By Josh Barro
Congress finally passed bills last week spending money on two things Republicans and Democrats had been saying for months they wanted to spend money on: keeping interest rates low on Stafford loans for college students, and building more transportation infrastructure. What held these policies up was a dispute over how to pay for them.
Democrats wouldn’t agree to defund the health-care law, as Republicans wanted. Republicans wouldn’t raise taxes on the rich, as Democrats wanted. In the end, both sides were able to agree on one way to raise money: tinkering with the rules that govern corporate pension plans, so that companies can set less money aside to pay for benefits, and send more money to the government.
The math is sort of complicated, but it’s important: The liability side of any pension plan is a stream of promised payments, many of which are due far in the future. To calculate the present cost of those future payments (and therefore how many assets are needed today to cover a pension liability tomorrow) the pension plan sponsor applies a discount rate, which is like a reverse interest rate. If you owe $1.10 in a year and are using a discount rate of 10 percent, you would need $1 on hand today for your liability to be fully funded.
Private firms that offer pensions are required by law to use a discount rate that is tied to interest rates on long-term, highly rated corporate bonds, under the theory that a pension obligation and a bond obligation are similarly risky: Each can be broken only if the company goes bankrupt. Since interest rates are currently near historic lows, companies are being told to set aside a lot of money for pensions; the lower the discount rate, the more cash you need on hand today to fund future liabilities.
Companies don’t want to set aside so much money. So they lobbied Congress to change the rules so that they can choose discount rates based not on current rates but on an average of interest rates over the last 25 years. Since funding a pension plan is an expense that companies deduct before calculating tax, a more lax pension funding standard will lead to corporations reporting higher profits, and paying higher corporate taxes -- making about $9.4 billion over 10 years available for highways and student loans.
DuPont’s former chief actuary advocated the new funding standards by arguing that subjecting firms to market discount rates creates an “artificial” need to increase pension funding. But it’s not artificial at all. A low-interest-rate environment makes it more expensive to promise fixed payments to workers in the future. An amount of money that is sufficient to cover pension promises when safe bonds yield 7 percent is no longer sufficient if those bonds yield 4 percent.
As a result of the new rules, corporate pension plans won’t have enough money on hand to cover their liabilities -- and if companies go bankrupt, those funding gaps will become the responsibility of the Pension Benefit Guaranty Corporation, which is run by the government. The PBGC is already strained because the weak economy has led to more pension funds going bust; letting companies fund their pensions less aggressively will only increase that strain.
Congress thought of that: When it lowered the pension funding standard, it also raised the premiums that participating firms must pay to the PBGC. But that’s part of the money grab, too: Congress will count about $10 billion of those extra premiums as paying for spending on other programs, like highways; if they’re also supposed to be there to shore up the PBGC, that’s double counting.
What we really need to pay for highways isn’t pension gimmickry -- nor is it more taxes on the rich or defunding Obamacare. What Congress should have done is raise the federal gasoline tax. The tax is fixed at 18.4 cents a gallon and hasn’t been raised since 1993, since which time it has fallen by a third in real terms due to inflation. Improving fuel economy has also eaten away at revenues.
A higher gas tax would be good for infrastructure finance and good for the environment, but it would require telling voters that if they want the government to do things, they have to pay for them. And that may be a bridge too far for either party.
(Josh Barro is lead writer for the Ticker. Follow him on Twitter.)
Read more breaking commentary from Josh Barro and other Bloomberg View columnists and editors at the Ticker.
-0- Jul/03/2012 18:45 GMT