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I just read an article in Institutional Investor, the December 2016 - January 2017 issue, on page 27 regarding the California Public Employees' Retirement Fund entitled "Jerry Brown's Battle".  The fund is $300 billion.   The question was whether the discount rate should be moved from 7.5% to 6.5% immediately or over a 20 year period.

I am not an actuary but, for plans like these, what would happen to the plan if the rate magically increased from 7.5% to 10%?   Generally would the effect of increasing the discount rate 250 BP for DB pension plans have a low, moderate or high impact to the calculations?  How sensitive are plans to discount rate changes?   If moving the rate downward 1% immediately or over 20 years is a huge debate....

I would appreciate thoughts and feedback on this.  

Regards,

Brad

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You have answered your own question.  If the timing of moving the rate downward by 1% creates a debate then moving the rate upward by 2.5% would have an impact that can only be described as HUUUUUUUUUUUUGE, or bigly.

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brad, the benefit payments of the big public pension plans are statutory, and reflect a stream of annuity payments extending 100 years into the future.  They represent the probable payments that will come due when employees become eligible to retire, and the expected payments to current retirees.  

The theory of present value is that you need to establish a monetary value today for those future payments.  If you discount those future payments based on the expected return of your portfolio of investments, you now have to make another assumption that your investments will grow and earn returns at a long-term sustainable rate.  The debate today is that these plans have assumed that they can beat the growth of the economy and the prevailing interest rates by some percentage.  If you assume the investments grow at current long term bond rates for quality investments, you would choose something in the 4 to 6% growth rate.

Can you imagine that borrowers would agree to a long term 10% cost of money?  If not, then you should  consider the 10% assumption a fool's choice.

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Thanks all for responding.   The secret sauce is in asset return.   If we could increase asset return 2.5%, I believe we could solve the pension crisis, both private and public.  The answer is to 100% eliminate the corporate income tax. 

The other tweak to the rules would allow pension funds to be quadruple or more funded, eliminating the penalty for overfunding a pension plan.  If so, the plan managers would have the freedom to invest in a portfolio that is higher performing yet slightly more volatile.  If the market does a 2008 nosedive, the plan remains 200% and recognizes a buying opportunity.

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Is it not true that if corporate taxes were eliminated (ignoring the impact on the money available to the government to cover the things that the government must do), most of the money would go into a combination of higher bonuses for the executives and lower prices to maintain market share.  Guaranteed - passing the bulk of the "savings" back to the shareholders through larger dividends would never happen. 

With the current rules for tax-deductible contributions to defined benefit plans (which permit funding up, at the very least, to 150% of liabilities), one almost never sees larger plans worrying about there being too much money in the fund. Further, without the incentives provided by the reduction in the corporate taxes owed that result from contributions to retirement plans, the corporations would probably reduce their commitment to providing retirement income to their rank and file employees.  No corporate taxes?  Then what incentive would there be to meet the requirements for a qualified plan?  Why not just give retirement benefits to the executives?  It is the corporate tax savings that make the effort to provide qualified benefits evenly slightly palatable.

 

Always check with your actuary first!

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My 2 cents,

Great points.

If we eliminated the corporate income tax, why would that result in higher executive bonuses?  The executives have done nothing extra when their company earns a higher ROI, why would they bonus?   If I was a stockholder of a company that paid out higher exec bonuses in lieu of a dividend to me, I would be enraged.

You're collating and conflating prices with tax policy.   I am not sure this makes sense and is true.  If the expected return from stock investing rises from 8% to 12% with the elimination of the CIT, any company not having a visible increase in its after-tax earnings would lose stock price and the interest of the investor.  As an investor, I would challenge companies to charge market prices for their product, not just enough to maintain their historical ROI.    

Employers should make contributions to retirement accounts as a value proposition, not a tax-driven proposition (as you propose).  Employers that offer complete benefit packages, including well-funded retirement accounts with a 4x funded plan, would attract better employees - an old argument.  That would be a market-driven, value proposition.   Or, I could work for the city of Detroit whose pension plan barely survived bankruptcy.   I would chose the employer whose plan was 4x solvent.  

If employers choose not to offer its rank and file employees a fair deal, those employees should leave and find employment elsewhere.   And, with no corporate income tax, it will be an employees' market, not an employer's market.

Thanks for responding.  Just some thoughts.

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4 hours ago, Brad Jacobs said:

If the expected return from stock investing rises from 8% to 12% with the elimination of the CIT, ...

I think there is oversimplification in this analysis.  It seems to assume that prices would be unchanged. 

You argue for the elimination of corporate income tax, but there might be equally valid arguments for the opposite: eliminate all tax on labor.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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Yes, it is an oversimplification because I think it would be impossible to predict market behavior fully and accurately when eliminating the corporate income tax, a 100 year old institution.  But, I do challenge the assumption that ROI will remain unchanged because corporations will just drop their prices.   If we live in a global economy, the correlation between prices and the CIT diminishes and I don't wish to conflate the two.  In fact, if I invested in a corporation who began charging less than market rates for its products, I would sell the investment if the board didn't fire the management.

Going form 8% to 12% is a wild guess, but I would say that most of us could agree that it would at least go up and not down.   But, I speak not as a trained economist.

I propose that all income, whether earned or investment, is taxed at the same marginal rate on the individual tax return.  I am not saying that only taxing investment idea is a bad idea; rather, it could be a great idea - I haven't given it much thought.  What I am saying is that we cannot get there from here.  We can easily get to my proposal.  The US income is approximately 90% IIT and 10% CIT (plus some gift and estate and excise taxes).  Replacing 10% CIT with IIT is within reach.   Replacing 90% IIT with CIT is not. 

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On Friday, February 03, 2017 at 5:39 PM, Brad Jacobs said:

If we eliminated the corporate income tax, why would that result in higher executive bonuses?  The executives have done nothing extra when their company earns a higher ROI, why would they bonus?   If I was a stockholder of a company that paid out higher exec bonuses in lieu of a dividend to me, I would be enraged.

...

If employers choose not to offer its rank and file employees a fair deal, those employees should leave and find employment elsewhere.   And, with no corporate income tax, it will be an employees' market, not an employer's market.

 

1.  Perhaps I am bitter and cynical, but with boards of directors that consist primarily of people who are CEOs for other companies, there is no pushback when executives give themselves unconscionable bonuses.  Why wouldn't they consider anything that lowers the cost of doing business (such as elimination of corporate taxes) as an excuse for bigger bonuses?  They have certainly never hesitated to do so when the reduction in the cost of doing business is patently borne by the company's rank and file employees.  How many times have we read of executives who follow up a dramatic layoff/reduction in force (even if justified by shaky financials) with another multi-million dollar bonus for themselves?  And shareholders choosing to invest in companies based on who overpays on executive bonuses and who doesn't?  How many 401(k) plans choose their investments based on such considerations?  Or even on how open-handedly the company pays out its profits as dividends?  Perhaps if the corporate income tax were eliminated, the market would pressure some of the companies to pass more back as dividends, but I think that effect would be more limited than you do.

2.  Perhaps it's my imagination, but isn't one of the problems leading to the radical differences between executive compensation and rank and file compensation that finding employment elsewhere is less of an option than it used to be?  What percentage of the workforce is working where they are working because they lack options?  I will believe that the threat of jobs being moved to lower-wage countries has been ended when I see it (and anyway, it used to be that companies moved jobs at will from the higher-paying northern states to the lower-paying southern states - any reason to believe that even if offshoring jobs was to be ended, it would translate into higher pay or more choices for rank and file workers?).

Always check with your actuary first!

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