Never mind the levy, put pension assets to work

A government with powers of taxation and regulation has a lot of leverage with an under-regulated industry reliant upon tax subsidies, such as, for example, the pensions industry. It should make them a Don Corleone-type ‘offer that can’t be refused’. By Michael Taft.

The Government has got itself into a bit of bother over this whole pension levy lark. But the complaints from the pension industry are a bit hard to take. In this regard, contributions from two leading pension experts – Gerry Hughes and Jim Stewart – are worth noting. We’re talking about an over-priced, under-performing industry that is reliant upon state subsidy which mostly ends up in the pockets of high-income groups. And we expect this industry to provide an adequate income in retirement? Please.

However, in the context of exorbitant fees, falling pension values, collapsing funds (e.g. Waterford Glass); with people struggling to save in the face of falling wages, higher taxes, rising prices and increasing interest rates – any policy departure is a recipe for uncertainty and anxiety.

And when people learn that the assets of Approved Retirement Funds – the savings vehicle of choice for the rich and fabulous – are exempt from the pension levy, they are right to conclude: here we go again.

In all this pottage how can we, at least, square one circle – make savings work for the economy? In this respect, the pension levy is a lost opportunity.

Daniel Gross has put forward an interesting analysis and prescription. In effect, he argues that Ireland doesn’t need the IMF, the EU or even in the short-term, the international markets to finance its debt. How could this be?

The little data published by the...Irish pension funds and...insurance companies suggest [they] own over €100 billion in foreign assets, of which about €25 billion are in non-Irish government debt and about €72 billion in foreign equities.

You can probably see where this is going. He suggests there is a mismatch. Whereas the Government pays exorbitant interest rates on foreign borrowings, the Irish private sector earns little on its foreign assets. So why not bring together the two?

...Irish pension funds and life insurance companies should somehow be ‘induced’ to invest their entire portfolio of gilts [foreign government bonds] in Irish government bonds. The €25 billion in financing that this would yield for the government is equivalent to the entire contribution of the IMF to the rescue package. A similar case can be made for the €72 billion in foreign equity investments. If two-thirds of that sum were also be invested in Irish government bonds, the total financing available...would rise to over €73 billion, more than all the foreign funds made available to Ireland under the rescue package.

In other words, farewell to the EU-IMF.

This is certainly provocative - relying on our savings to regain our ‘economic sovereignty’. There are a couple of problems with this. First, this form of ‘financial repression’, whereby the Government pretty much tells banks and pension funds where to invest their money, would be a mighty intervention. It would not only be fiercely opposed by financial institutions, it would run up against the EU’s free movement of capital (even though the EU/ECB has pretty much trashed that principle of ‘free movement’ by forcing the sovereign to pay creditors of private institutions).

Second, even with pension/insurance funds buying out debt, we still have a debt sustainability problem. It would still be problematic regardless of the ESFS facility. We may still find ourselves back in the arms of the EU-IMF and the danger of defaulting on our own pension funds is not a pretty scenario. And with the Government intent on pursuing irrational austerity policies, those problems are magnified.

Still, Gross’s prescription is enticing and sensible. So how about this for a plan: we fund a five-year €15 to €20 billion investment programme with long-term negotiated (even inflation-indexed) bonds sold to our pension funds. Alongside this we scrap the pension levy (it’s really pocket change in the grand scheme of things).

This could have considerable economic benefits:

First, pension funds would have an asset that would be repaid with annual interest. Even at 4% interest it would be quite a steal given that their portfolios average something like 1% annually over the last 10 years.

Second, as this would be a temporary investment programme, it wouldn’t affect our underlying budget deficit (the investment programme would be treated just like the bank payments – one-offs).

Indeed, and third, it would benefit our underlying deficit as this investment would be making an economic return. For every €1 billion in capital investment, we raise approximately €400 million in tax revenue in the first year alone while reducing public spending through employment gains.

And after the programme we would have assets on the balance sheet that will continue to earn the economy money: a Next Generation Broadband network, a state-of-the-art water and waste system, a best-practice early education/childcare network, an up-skilled workforce, etc.

Would we have to force the pension funds to purchase the bonds? Kinda, sorta, not really-ish. A government with powers of taxation and regulation has a lot of leverage with an under-regulated industry reliant upon tax subsidies. The Government could make a Don Corleone-type ‘offer that can’t be refused’. Indeed, the persuasion could be so subtle you wouldn’t even have to show fund managers the instruments.

The issue of national governments resorting to domestic savings as a means to both finance and reduce the debt is quickly rising up the agenda. As Reinhart and Sbrancia put it:

...it has also been collectively 'forgotten' that the widespread system of financial repression that prevailed for several decades (1945-1980s) worldwide played an instrumental role in reducing or “liquidating” the massive stocks of debt accumulated during World War II in many of the advanced countries, United States inclusive.

So let's dip our toe in the water with an investment programme that can put people back to work and growth back in the economy. To date, we have following irrational strategies - austerity, bailing out insolvent banks - that have continually limited our options and landed us in the bail-out.

Let's start discussing strategies that open up options and can free us from the bail-out trap we find ourselves in.

It will lead to better outcomes. And it'll be a lot more fun than debating which hospital ward we'll close next or how many people are emigrating this week.

 notesonthefront.typepad.com

Image top: sheeshoo.