Monday, February 22, 2010

Solving the pensions Ponzi scheme

For those who are not familiar with your humble Devil's view of National Insurance Contributions (NICs), I'll just let the Scary Clown outline what a Ponzi scheme is.
Just in case you don't know what a Ponzi scheme is, it works like this: I get N people to pay money into my "fund" and promise them that the fund will pay out some crazy benefit. They all like the idea and get their friends to put money in. As new people add more money in, I use the money coming in to pay out to the original investors and skim off a chunk for myself. The more people chucking money into the pot, the more I can skim off and the more I can dish out to investors. But since I'm not doing any kind of investing, the problem comes in when people stop chucking money into the pot, or even worse, when people want to withdraw their money.

Then all hell breaks loose, as it did with the Bernie Madoff case.

But what far too few people realise is that the government's "National Insurance" is nothing but a Ponzi scheme. While the economic population is growing there is no problem meeting pension requirements (and all the other things that National Insurance ostensibly pays for) but when the population starts ageing and you have more claimants than contributors, it all gets a bit messy.

Obviously, this whole shit-heap is going to have to end at some point—probably in tears. As loyal readers will know, I am always interested in the way in which we might manage transitions towards a more libertarian society. Thus it is with great pleasure that I point you to a solution over at the Adam Smith Institute.
An obvious choice, denied to voters

Imagine you were forced to pick between two options: Option one – you give me £10 today for me to safeguard for you, but there is a very high likelihood that tomorrow, when you wish to claim, I will default. Option two – you give me £5 today, and can invest your remaining £5 on your own, again with the assumption being that I will likely default tomorrow.

Whilst it's hardly a wonderful choice you would surely choose option two, to minimise your losses. However, when it comes to National Insurance Contributions (NICs), the government only gives you option one, and then pretends that you're safe.

"But wait!" I hear you cry. "The government wouldn't default on the state pension!"

"In which case," say I. "You are incredibly naive." I'm afraid that the signs are all there in various stories over the last few years—most pertinently, in this case, in the story about how the government were planning to force people to contribute a percentage of their wages towards a private pension over and above their NICs.

So, given that there is every reason to believe that the government—if not about to default anytime in the very near future—is attempting to shore up the ever more crippled finances, there might be a better way.
What about if the government offered people both options?

Either;
Every employee pays 11%, to be paired with a contribution of 12.8% from their employer. When the employee retires, provided there is enough cash in the National Insurance Fund, they receive a state pension, just as they would have under the existing system.

Or;
Every employee keeps their 11% share as income to be invested into a private pension arrangement, and the employer continues to pay a 12.8% stake towards national insurance. The employee waives their right to a state pension, but receives a 'recognition bond' that entitles them to slightly less than the value of their employee contribution to the National Insurance Fund to date.

The choice is thus open for every individual to make, and logic dictates that the choices will be made rationally, relative to each individual's age and circumstances. Most young people, and in particular those who have just started working will certainly be better off taking the private route, even if this means they will not get any personal benefit from the contribution of their employers. Older people, and in particular those close to retirement, who have been contributing to the fund over a lifetime's work will be much more likely to stay with the national insurance scheme.

Of course, the need for this choice is largely depending on my initial analogy – it assumes that the government is likely to default at some point in the future.

As I have pointed out, it is reasonable, I think, to assume that the government will, indeed, default. It may not be in the next ten or twenty years but it is safe to assume that, by the time that I reach retirement age, it will have done so.

NuLabour's solution was to keep your 11% and your employer's 13% and make you pay even more on top (and remember that both portions of NICs are going up by 0.5% in April): in the ASI's solution, the government keeps the 13% to pay out to current pensioners, and you get to invest your 11% as you see fit.

But this must be some kind of crazy talk! It'll never work, surely? Er, yes it will...
Greater Returns for the people

The benefits of pension privatisation are undeniable. The Chileans are certainly richer as a result of their privatisation scheme. This is despite heavy regulation that accompanied the scheme in the early years, which forbade, for example investment in foreign equities. As Chile's economy has developed, more opportunities have arisen, and even greater returns can be realised with less regulation being necessary. The plans from America have highlighted this trend too. The projections are much more favourable when regulation is looser, for example allowing a greater percentage of peoples' money to be invested in stocks, as opposed to bonds. Nonetheless, even with a 50/50 split between bonds and stocks, the SSA scoring looked favourably on the financial returns of the Cato plan.

Those who invested in private pensions have comfortably produced returns more than three times greater than state pensions, because of the efficiency with which they are invested. It is because of this that most people will be better off, even if they have to sacrifice the share of NICs paid by their employers. Furthermore, Michael Tanner of Cato noted that notwithstanding the fall in the value of the stock market over the last year or two, an employee who started investing 40 years ago would still have done much better had they invested privately than had they relied on Social Security – had they been given a choice. This plan is a sustainable way to give them that choice.

Yup: it worked in Chile and it looks as though it will work in the United States. Not only does it work, but everyone is better off. This can only be a good thing. So, which party is going to implement such an eminently sensible plan?

Anyone? Bueller...?

31 comments:

darjeeling junkie said...

Yup: it worked in Chile
No,it didn't.It was and is a horrendous fuckup in Chile.

Mark Wadsworth said...

It's all too gimmicky.

Most sane people accept that the state pension is pay-as-you-go, which is the cheapest and least risky way of doing things. National Insurance is just another kind of income tax and has nothing to do with anything. They could just as well base your pension on the amount of income tax or VAT or council tax you've paid.

As it is a political necessity to keep older people from starving, the way forward is a taxpayer-funded, flat rate universal Citizen's Pension. We can argue hotly about the retirement age and how high it should be (where infinity and £nil are possible options - that would sort out high house prices at a stroke - and hence be the ultimate vote loser!).

Above and beyond that, tax breaks for pension savings or compulsory private savings are a hiding to nothing - if there's money left over, it is always better to cut taxes generally than offer 'tax breaks' to 'encourage' this, that or the other.

darjeeling junkie said...

In fact,the net result of Chile being(forced to be at the bareel of a gun,so much for liberty,eh what what?)a libertarian research project has been fuckup after fuckup.

Anonymous said...

Pensions.
A lot of people don't have private pensions.
Simply because they are being taxed too highly.
Or their bills are too high due to taxation.
Mind you the public sector pigs are alright.
Disgusting.
I invest privately I do not trust pension schemes anymore.

darjeeling junkie said...

Disgusting.
I invest privately I do not trust pension schemes anymore.

Yes,your money will be safer invested in Enron.

Anonymous said...

This post is about the transition to a libertarian state not how it would be ideally. Ideally people would take personal responsibility and save up for their retirement. But you can't just say that everyone who starts work today will get a state pension, and everyone who starts work tomorrow will be on their own. Thus, Mark Wadsworth, we need some gimmicks.

darjeeling junkie: [citation needed]

Devil's Kitchen said...

Thank you, Anon.

And you certainly cannot say "you're on your own, but you still have to pay full NICs to the state"...

DK

Blas said...

I am buying Gold and Silver rather than contributing to any sort of pension.

No 'management fees'. No counter party risk. All I need to do is keep the stuff safe, which is easier than you think.

And I could not give a ho's mimsy if they outlaw it - it's a metal, and it is mine.

Lord Lavendon said...

Mr Kitchen, agreed the current set up is a ponzi scheme. The further problem with pensions has been the closure of the private final salary schemes (not in the public sector though), caused by longer life, government over regulation, Gordon Brown's tax raid and the corporates not funding them properly.

Issues with your suggestion -

1. the national insurance is not there simply to fund the state pension, but also the rest of the vast social security budget. Appreciate that this does not work in practice (£95billion NI compared to £190 billion Social welfare budget), but you would need to rethink the whole social welfare budget. Say if you abolished every other benefit and left NI as a pension fund only, you could reduce NI accordingly.

2. if you allowed people to opt out of a state pension, I suspect the whole thing would come crashing down.As I would suggest high earners would opt out and there would be a fraction of the money needed to fund those that did not.

Personally I would see the state pension as a minimum provision or a safety net.

The ideal solution in my view would to have a trinty of pensions :

1.A fund managed by the individual-2.5%
2.The state pension- 5&5% NI
3.Corporate pension- 3%&6%

To help business fund pensions, abolishing rates and corporation tax would be a start.To help the individual save, we need to reduce income tax to a single 15% rate with a £10,000 starting threshold.

Roger Thornhill said...

Totally agree it is a Ponzi scheme and needs to be fixed.

There will be pain. How much and in what form is the question. It is all a matter of transition.

I think we need to consider moving from a "defined benefit" scheme to a "defined contribution" scheme. This will scare the bejeezus out of many people, it has to be said. Safety nets are a problem also, for to mean anything they discourage self-reliance and will likely have us back where we are right now. It is not easy.

As a side note it is madness IMHO for anyone to tie their pension into a company-managed scheme.

Time and again companies fail, new owners wriggle out of maintaining it etc etc.

Now, it is quite reasonable and desirable for companies to contribute to *a* scheme as a form of incentive, but for a company to say it has to be THEIR scheme and they are the ones to manage it and sometimes not manage it properly while government regulations or terms prevent "escape" for the worker is dysfunctional. It reminds me of mill town companies that paid people in tokens only usable in the company run shop. People are not rewarded, but held hostage.

darjeeling junkie said...

Lord Lavendon
The social security budget is not so vast as a share of government spending.You're right to opt for keeping the state pension as a safety net.But I think you will find that some of the younger,more able bodied moochers are cheaper to bribe than it would be to invest in all the moats,drawbridges and machinegun turrets needed to safeguard the productive members of no such thing as society.It might be cheaper to push onwards with this whole dignity-in-death malarkey.
I note with amusement that in your scheme business goes buckshee while the cherished individual still has to contribute,sorry,be looted of 15%.

paul said...

Because investing in stocks and bonds in the near future is going to be such a smart idea, NOT!

Anonymous said...

It's just impossible to earn enough money in 40 years to cover your living cost (and more) for another 40 years without working.

Anyone who sells you money tomorrow for cash today is on the make.

And it won't be that the state defaults, the pensions (gold-plated or not) just be inflated away -- in Russia it took only 3 winters to solve the babushka problem permanently.

No granny, no cry.

Lord Lavendon said...

Darjeeling junkie, actually just got the figures from HM Treasury website. Social Security spending is estimated to cost the government £190 billion in what it calls "social protection" and a further £29 billion in "personal social services". That is £219 billion. The total government spending is estimated at £676 billion. So almost a third of government spending is absorbed in this way and this makes up a total of 14.6% of GDP; it is by far the largest government-spending department. If you want to be pedantic and call heath part of the social security you can add a further £119 billion. Contrast this with defence which is allocated a mere £38 billion or education at £88billion. So not sure how you can state, "The social security budget is not so vast as a share of government spending".

Re my 15% of income tax and a £10,000 threshold, add to this my cut of national insurance to 5%, it is actually going to benefit the individual. Cutting the vast taxes on business will also indirectly help the individual by releasing more money for pensions, dividends and capital investment.

All of which flow into the real economy and will generally make people richer as a result. The increase in personal income as a result, would allow for further reductions in taxes over time, possibly even to the result of abolishing it altogether if that is your fetish.

Lord Lavendon said...

Also, the bit about abolishing tax specifically referred to income tax.

darjeeling junkie said...

I see,you're using your own highly specialised definition of "social security".Listen,if you meant to include "social protection" and "personal social services" why didn't you just say so?
Cutting the vast taxes on business will also indirectly help the individual by releasing more money for pensions, dividends and capital investment.
I don't see how this can be said with any certainty(will help the individual)
unless the individual happens to be a dividend-drawer.But I suppose this is the point,right?Surely it's simpler(and fairer) to get rid of income tax and increase tax on corporations?
Shareholders want their loot year on year.Employees have to wait quite a long time to find out if their pension hasn't been raided.Assuming they make it to retirement.And then there's senior managements bonuses.
And you've still got your hoardes of moochers waiting for you outside.Sounds like paradise!

Lord Lavendon said...

DJ, My dear fellow, not sure how I can listen to you as this is a communication in writing?

I have not created a 'specialist ' definition of social security. I have simply used definitions as the government does so. I would perhaps suggest you were writing narrowly about the cost of pensions to the whole government spending?

Also, regarding you second point, now apologises if you are :

a) A fund manager
b) A pension trustee
c) A pensions expert

But when you say "Shareholders want their loot year on year. Employees have to wait quite a long time to find out if their pension hasn't been raided."

Ask yourself a quick question: "WHO owns the largest percent of the listed companies in the UK? "Yep that's right; pension funds & insurers, who are investing any funds you might have in a company right now on your behalf.

Therefore if you allow companies to flourish and be profitable the higher the dividend and the value of that company and therefore the bigger your pension pot (unless you are a state worker who still have the gold plated system) and your wealth in retirement.

Furthermore a profitable company will be able to expand &invest. Therefore more employment and more expenditure are spent on other firms (e.g. medium/small biz, who often rely on larger firms) thus multiplying the wealth effect.

Corporation tax and rates will still take about £58 billion this year, by abolishing these you are giving a vast stimulus to the economy.

By reducing income tax to a single 15% band with a £10,000 threshold, you are taking out of the system the very poorest (min wage) workers. And again ploughing a further £60 billion into the economy.

And make most people who WORK better off.

darjeeling junkie said...

How about if your wages were slashed-that might make the company you work for more profitable,mightn't it? So,less wages=bigger pension pot and more wealth in retirement? Great.
Do you really think all of the problems with pension funds are the result of insufficient profit in the companies invested in?Ask yourself:If something is being done on my behalf does it automatically follow that it is being done in my interest? I don't really see how anything you have said re corporation tax and profit,on whose behalf megabucks are being gambled,pension funds and whatnot proves that workers pensions would be any safer from being raided.
Apologies for the free-jazz writing style.
One last thing:I'm guessing that abolishing such a big revenue stream is going to make it quite hard to stock up on machinegun turrets,and given that the average wage is in the low twenties,well you know what they say,15% of not much is fuck all.I reckon you're going to have to bring in a whole bunch of consumption taxes.Will people really be so much better off?

Lord Lavendon said...

DJ, replies in CAPS :

"How about if your wages were slashed-that might make the company you work for more profitable,mightn't it? "

YES, IF YOU WANT POOR STAFF MORALE AND IF YOU INSIST ON KEEPING TAX TOO HIGH.

”So,less wages=bigger pension pot and more wealth in retirement? Great.”"

NO,YOU STATE THE REVERSE OF MY CASE.

“Do you really think all of the problems with pension funds are the result of insufficient profit in the companies invested in?Ask yourself:If something is being done on my behalf does it automatically follow that it is being done in my interest? I don't really see how anything you have said re corporation tax and profit,on whose behalf megabucks are being gambled,pension funds and whatnot proves that workers pensions would be any safer from being raided."

NO TO THE FIRST POINT. REGARDING YOUR INTEREST YOU ARE QUITE FREE TO HAVE A SIPP AND DO THE INVESTMENT YOURSELF.THE PART ABOUT WORKERS PENSIONS BEING SAFE FROM "RAIDING" IS A COMPLETELY DIFFERENT MATTER TO THE ONE BEING PRESENTED HERE AND IS A DISCUSSION FOR ANOTHER DAY.

"One last thing:I'm guessing that abolishing such a big revenue stream is going to make it quite hard to stock up on machinegun turrets,and given that the average wage is in the low twenties,well you know what they say,15% of not much is fuck all.I reckon you're going to have to bring in a whole bunch of consumption taxes.Will people really be so much better off?"

IT IS INTERESTING YOU WERE SUGGESTING IN AN EARLIER POST THAT INCOME TAX SHOULD BE ABOLISHED OUTRIGHT AND NOW YOU CHIDE ME FOR HAVING TO FIND ‘EXTRA’ MONEY VIA CONSUMPTION TAXES. YET INCOME TAX BRINGS IN £140 BILLION AND THE TAXES I HAVE MENTIONED £58 BILLION. I BELIEVE THESE FIGURES SPEAK FOR THEMSELVES. IN ANY CASE YOU ASUME THAT I WOULD BE FOLLOWING THE LUNATIC PLANS OF THE CURRENT GOVERNMENT RE SPENDING. BUT I WOULD NOT, SO I WOULD NOT HAVE TO INCREASE TAX, BUT CUT TAX.

Anonymous said...

LORD LAV,just forget it. The guy is probably one of those fucking winging pensioners who has seen his portfolio go down. he's just bitter and twisted. Like most baby boomers.

darjeeling junkie said...

"IT IS INTERESTING YOU WERE SUGGESTING IN AN EARLIER POST THAT INCOME TAX SHOULD BE ABOLISHED OUTRIGHT AND NOW YOU CHIDE ME FOR HAVING TO FIND ‘EXTRA’ MONEY VIA CONSUMPTION TAXES."
I think you will find that what I suggested is that it would be fairer than abolishing corporation tax but merely reducing income tax(and NI,I did notice that).Fairer,rather than fair.
It may surprise you to learn that I had not assumed you would be folllowing the lunatic spending of the current government.This is why I mentioned moats,drawbridges and machinegun turrets.Yes,sad to say,but many have not heard the libertarian gospel and will not be volunteering to do the decent thing in order to make way for the heroic,hardworking John Galts of this world.I don't know if you are aware of it ,but there used to be something called a Full Employment Policy in this country.Something for you to ponder when you lament the social security budget.

beddy byes for me soon!


Baby-boomer! the cheek!

Lord Lavendon said...

DJ, it has been a most interesting discussion. As a point of record I am not a Libetarian. Are you a socialist?

Anon 00:32 said...

DJ = SH? just a thought

Mark M said...

The government won't ever default (by the technical definition), but it will reduce the value of your 'investment'.

ConHome had a story recently of allowing pensioners to defer council tax payments to be taken out of the value of their estate after they die. This is laying the foundation for a reduction (by stealth) of the state pension.

If you defer your £100 per month council tax then you will, obviously, have £100 per month more cash in hand. So, a reduction by stealth would see the pension rise slower than inflation, Knowing this lot they'd probably reduce it by the whole £100, so that you're in the same cash position as you were previously, but when you die you get your next of kin to send a cheque.

Anonymous said...

Australia has compulsory superannuation. An employer must contribute a minimum of 9% of the value of your wage into an approved superannuation fund. It doesn't come out of your wage - it is in addition to it. (I believe back in the 1980s there was a bit of a trade off - lower wage increases for super contributions.) Employees can contribute in addition to either the same fund either before tax (no income tax paid on salary sacrificed contributions but there is a contributions tax of 15% = to the lowest tax rate); or after tax (no contributions tax).

Government pensions are means tested and no specific contributions are required to access these - it's income support for those with insuficient means of support.

There are a whole raft of incentives for people nearing retirement age to contribute to superannation (you can work fewer hours, salary sacrifice into your super thereby reducing income tax, and draw back some money from your super - a bit of a churn but the idea is to retain older workers for a few more years).

Not a perfect system but super schemes are heavily regulated. Also, people can opt for a self-managed fund and as long as they comply with the regulations they don't need to rely on fund investment managers (they could instead invest in property or example).

Mark B. said...

"It doesn't come out of your wage - it is in addition to it."

Yes it does " . . . come out of your wage . . . " -- because the employer can't use that money to give you a raise.

"(I believe back in the 1980s there was a bit of a trade off - lower wage increases for super contributions.)"

Precisely -- and that's still the case.

As mentioned previously, the governments, both here in the U.S. and there in the UK, will default on their engagements to pensioners (retirees over here) by deflating the currency to the point that your monthly check and a half-ounce gold piece will get you a cup of coffee. Dr. Walter E. Williams made precisely that point some years ago and I'm relatively certain he's right about it.

'Berg

Lola said...

One of the key problems with all the state unfunded pension liabilities, including state employees, is that there is no connection between the benefits derived and the success of UK Plc.

Private funded pensions are directly linked to the success of UK plc - witness the flat FTSE returns over Brown's Terror - and suffer when the UK suffers, but not the State unfunded schemes.

Now, I am also with Mark Wadsworth on a basic citizens income/pension idea (based on radical reform of the tax system) but all other schemes should be funded, and final salary schemes outlawed. Plus I'd cap all the tax breaks for pension contributions.

Tuening to the NIC financed schemes, I have for years advocated clients view the contracing out choice on the basis of whom you trust least, HMG of the insurer/fund manager of your choice. Most choose the insurer.

Now as a transition arrangement I will look at anything that get's us from the stupid place we find oursleves in and a more equitable future.

Uranus, The Magician said...

Frankly, at 74 years of age, as long as my state pension sees ME out, I couldn't give a flying fuck.
(Just like my interest in recycling, global warming and all other touchy feely shit!)

Anonymous said...

The ability to invest a greater proportion of a fund in equities should, over time, produce a better return than from bonds.

Never forget that asshole Lord Mynah's rules requiring pension funds to invest a greater proportion in bonds were introduced, purely coincidentally I'm sure, at the time our apology for a government realised, belatedly and unacknowledged at the time, that it was going to have to raise massive amounts of debt for many years if it wanted to enslave the British!

Peter Grimes

Nick said...

The social security budget is not so vast as a share of government spending.

Bollocks. It costs more than is raise in income tax.

It's a ponzi, and its collapsing.

5 years on the retirement age for your state pension is 5 * 5,000 = 25,000 pounds of default

Vicola said...

I'm pinning my retirement on a major Euromillions win. I figure it's a better bet than expecting the government to provide by the time I reach retirement age, which will be approxomately 150 years old given the state of the countries finances.