So there I was, mid-May in Dublin at the Foundation for Fiscal Studies’ 24th annual gathering, The Fiscal Treatment of Property, expanding on the topic Lessons from the United States and explaining US real estate taxation to a roomful of tax wonks. 

Class, can you say ‘locally autonomous control’?

[Click here to access my whole presentation, in pdf.]

You may not think the subject gripping, but they did, because they’re giving serious consideration to introducing annual real property taxes after thirty years without any, and they know that doing so is political dynamite.

Just propose raising taxes, and run

If you’re going to do this, I advised them, link local taxes to autonomous local control of visible local services: schools, police, firefighters.

Local control over real estate taxes also allows low dexterity in managing economic growth and property development, particularly via the use of targeted incentives, including:

PILOTs and redevelopment areas

1. PILOTs.  Payments-In-Lieu-Of-Taxes, where a municipality can structure any arrangement it

PILOTs require state-level authorization, and tend to be popular only in slow-growth already-urbanized areas with reliable high land values and a death of affordable housing, as evinced by the three states I cited (Massachusetts, New Jersey, and New York).  In lower-value states where other revenue sources are hard to come by and even the local real estate taxes are seen as expensive and hence a political risk, the tax man tends to be more aggressive with the assessments and the city council tends to be stingy with the abatements.

Even 121A couldn’t save the Jamaica Plain shoe factory

Originally these state enabling statutes were aimed at protecting industrial real estate, such as Massachusetts’ hopeless quest to keep the shoemaking business, but after those industries all collapsed in the Fifties, killed by the air conditioner which enabled them to transplant to the Southeast and Southwest, the late-Sixties saw them reused for affordable housing, which is today the dominant claimant for PILOTs.

2.  Redevelopment Areas (RDAs).  Another local-option initiative targeted to high-growth, high-density, high-value markets.  In an RDA, the locality draws a boundary around a core area, usually the central business district or an expanded downtown.  Expecting growth within the designated area, the locality seeks to assure that the rising real estate values do not totally price out affordable housing.

RDA map

Land value being a residual, these localities know they cannot stop prices from rising, so instead they take a portion (10% to 25% is common) of the increased real estate tax revenues derived from rising values within the RDA, and siphon that into a reserved ‘Housing Set-Aside Fund’.  HSAF proceeds are typically accumulated and lent out as soft debt to fund increased affordable housing.

Linkage, incentives, and Community Preservation

In addition to those two direct manipulations of the amounts or uses of real estate taxes, I highlighted three other American taxation/ land use initiatives, all of them locally generated and locally controlled. 

3. Linkage.  Linkage, as it has come to be named, has a more controversial reputation because of its targeting.  Within a designated area – again, usually a high-value zoning-constrained high-demand section of the city, usually the central business district – the city requires any up-zoning proposal to provide new affordable housing ‘linked’ to the new development in a stipulated ratio: so many square feet of new affordable housing for each hundred square feet of increased density approved.

Linkage’s structure flows from impeccable economic logic.  Most downtown developments are non-housing uses – retail, hotel, office – which generate jobs.  Good, but with those jobs come people, and the people either need housing locally or add to the traffic burden.  Either way, unless affordable housing is advantaged somehow, the non-housing uses will increase, exacerbating exclusion and traffic congestion – unless, that is, affordable housing is ‘linked’ to each incremental non-housing development, to keep the uses mix in balance.

Linkage comes in many forms.  Some are formulaic: X square feet of new affordable for Y square feet of non-housing.  Some are custom-negotiated, like the UK’s Section 106, whose design flaws I’ve already chronicled (at length). Some, like the Union Army during the Civil War, allow substitution – instead of delivering value in kind, the developer can simply pay a surcharge of $Z per square foot of increased zoning. 

How many of them were bought substitutes?

It’s this last that gives linkage its poor reputation in some quarters, as it smacks of the papal indulgence, or a bald toll to purchase approved up-zoning (instead of having each upzoning request considered on its own merits as being good or bad for the city’s development).  Further, unlike RDAs, linkage is zero-sum; every dollar of affordability delivered (either directly via affordable square feet or indirectly through linkage transfer payments) is one dollar less of land value.  Done clumsily, or to excess, it looks less like urban planning policy and more like a gotcha tax (whose motto is the Latin for, “because we can”).

I make the rules

Linkage is the flip side of PILOTs – taxing some properties higher or lower based on their perceived contribution to or deduction from the city’s overall use-of-property balance.

Too much reliance on one thing?

4. First-time homebuyer incentives.  Like linkage, homebuyer tax-credit incentives (like the Washington DC homeownership tax credit) are a one-time rather than an ongoing payment, and perhaps could have been excluded from my talk, but I included them as further illustration of how the community, if given local autonomy over zoning and real estate taxation, can customize extensively.

5. Community Preservation Acts.  I’m on record (four years ago! how blogging time flies) as endorsing the Community Preservation Act as a case study in good incentives, although in the intervening four years I’ve cooled somewhat after posting about localities, who saw the money just sitting there, snitching it for just-any-other purpose:

Such a problem is illustrated, unfortunately, by the expenditure creativity being displayed by various cities and towns around Massachusetts as they transmogrify the original legislative purpose of the Community Preservation Act’s money into … well, whatever they can think of. As revealed by yet another insightful policy article from MassInc’s, free CommonWealth magazine:

Moving the goal posts

Designed to create open space and affordable housing, the CPA is now being used to pay for sidewalks and artificial turf

If I write the rules, there’s no rule against it, right?

Where the ring-fencing breaks down, the CPA is just another surtax – and worse, because it flows via state match to localities that voted the override, it turns out to be reverse redistributive, giving  more to richer communities and less to poorer ones.

Finally, I devoted only a fleeting commentary to the implications of a real estate downturn on local finances:

Subprime’s consequences

All strung und drang aside, US foreclosures are concentrated in five states that can be divided into three conceptual categories:

1. Weak long-term economy (Michigan) dragging down values.

2. Speculative overbuilding run amok (Arizona, Florida, Nevada) because of low barriers to entry.

3. A whipsaw of overbuilding and skidding economy (the one and only California).

In light of all that, how do the US and Ireland compare?

Through the looking-glass: two ways of taxing

Ireland’s taxation is predicated on building and reselling of housing.  When times are good for the property market, government is awash in cash.  When times are bad, the cash dries up completely.  That’s probably contra-indicated because it’s in bad times that government is called upon to do more, and in good times it probably should do less. 

In short, I told my hosts, from what I could see of the US, and what little I understood about Ireland, a move to a recurring real estate tax on residential property would be wise – and the only way to do it without committing political suicide would be to connect it directly to increased local autonomy over visible local services. 

When the institute issues its report, I’ll let you know what they recommend.

Somewhere, over the rainbow, taxes work

Send post as PDF to

No real estate tax escrows collected by your mortgagee. 

No assessments, no city assessors.

Before you smile too broadly, I have to mention some other George-Spiggott-inspired conditions of the scenario:

I want only your immortal soul

No local autonomy on schools, police, fire, health.  All would be funded from the national government in decisions where you had no input.

Nevertheless, your property would not be free from tax.  On sale, you’d pay a transfer tax fee, collected by national government, which rebated money back to your community. 

Would you be happy or sad?

There is such a place.

Irish revenues have fallen off the cliff

The Republic of Ireland. 

In 1978, Ireland abolished local property taxes, and substituted a 6-7% ’stamp duty’ (real estate transfer tax).  From the mid-1990s onward, with the EU, the Euro, and the common European marketplace, immigration swelled Ireland population by 35%, adding about 1,500,000 people and over 500,000 new homes.  Prices boomed, and as they did, the state’s coffers bulged with stamp duty revenue.

Now prices have busted.  Every property-related statistic out of Ireland is gloomy.  With sales stopped dead, the government is receiving minimal revenue, yet it has obligated itself to provide high-quality local services throughout the country.  The party in power has miserable approval ratings and got walloped in the June local and European Parliament elections.  Should Ireland – might Ireland – could Ireland re-introduce recurring taxes on real property (as it was described by Chris Heady of the University of Kent)?  Is such a move good policy?  Is it political suicide?  If it is good policy, how can the government prevent political self-immolation?

I’m different and I don’t care who knows it

When I heard all this, I was agog, the more so because I learned about it via a request from the Irish Foundation for Fiscal Studies (FFS) to address their 24th annual gathering, The Fiscal Treatment of Property, on the subject of Lessons from the United States.

[Click here to access my whole presentation, in pdf.]

Now, gentle reader, you may think this an easy thing to rattle off, but I invite you to pause a moment.  You will have 45 minutes to explain the American property tax system to a nation that has not had one for thirty years, a nation whose area is roughly that of New England and whose population smaller than Massachusetts’. 

When everything is different, where do you start?

They asked me and yes I said yes I will Yes

What can you convey that may be useful in an utterly different context?

(By the way, in 1978 something occurred equally monumental to US real estate taxation.  I’ll let you ruminate for a while on what it was, and for extra credit, how it might have lessons for the Irish situation today.)

I started with the most basic point of difference – the triune government and its multiple ways of extracting taxes from the citizenry.  Have you ever counted them up?

Who’s got their hands in your pocket?

After I put this chart together – it’s a composite, an educated guess of the ranges – I was surprised that while the federal government gets the lion’s share, it’s local government that has the most diversity, with two guaranteed sources (real estate taxes and water/sewer) as well as the ability to levy other little pickups (and I didn’t list taxi-meter surcharges, soak-the-tourist hotel taxes, and speed cameras). 

I was also surprised that more than likely, you pay more in local taxes than you do in sales taxes.  Did you know that?  I didn’t.  I suppose it’s because the real estate tax bill is computed for you, whereas you have to do your own state taxes. 

Your mileage may vary because you may be in a high income-tax or sales tax state (like New York), and as a general rule, state taxes are high when real estate taxes are low, and vice versa.

[Any reader who has a chart of both, please email me the data or the URL; I'll be really interested. – Ed.]

How localities make ends meet

The reason is simple: localities that don’t get revenue-sharing from their state government have to make it up on their own.

Localities also like homeowners, preferably richer homeowners, preferably with fewer children, and it will surprise you to learn that the US lags more than ten points behind Ireland in homeownership: 68% to 79%.

Are higher numbers better?  Ownership percentages and mortgage debt relative to income

Not too surprisingly, when the homeownership rate is very high, so too is the relative level of mortgage indebtedness relative to income.

Yet the correlation’s not linear, with the US at 101%, Ireland 116%, Australia 120%, and Britain 130%.   Fortunately, debt is a balance sheet number, and payments are only a percentage of the debt, so that a ratio above 100% isn’t necessarily evidence of insolvency  Still, these are not statistics to be proud of.

They do mean that residential homeowners form the backbone of local tax revenues, including state tax revenues.

The importance of recurring taxes nationwide

While I confess surprise at the outliers of Illinois and Wisconsin, and the anomaly of Texas, overall the nation shows a pattern, with highest tax rates in the Northeast, lowest in the Confederacy (Georgia and Florida get a boost because these states have been urbanizing and gentrifying.

One state defies the trend: California.

Why’s California so light?

Any guesses why, readers?

As this was only of secondary importance to my Irish audience, I went back to the basic real estate tax budget algebra:

Seen in a blog post near you!

Real estate taxes: basic budget algebra

Having explicated this at length previously, I won’t rehearse it here.  The main point I wanted this audience to grasp is that taxation can be calibrated by millage rate, and sounds not too expensive: so many dollars per thousand. 

Further, when there’s a hole in the budget, you can plug it by fiddling the millage rate:

– Budget hole gets bigger? Raise the millage rate

– Real estate values drop? Raise the millage rate

– Got asset values you want to favor? Change their fractional assessment

You can also discriminate against some asset classes by discriminating in favor of others.

Tax ‘em too much and they revolt

But you have to be careful, or the taxpayers will revolt.  And that, I pointed out, is a dangerous backlash:

No taxation without representation!

Our first tax revolt came in 1773 and was a flashpoint in our eventual revolution and independence from Britain, on the memorable and valid slogan, “no taxation without representation.”  At the same time, in 1978, the citizens of another great republic expressed their revolt over too-high taxes by passing a statutory cap, Proposition 13, which single-handedly blocked the growth of California’s real estate taxes as a source of state and municipal revenue.

Personally, and from the safe distance of 3,000 miles, I think Proposition 13 one of the worst solutions ever forced on a government – a neck tourniquet for growth.  No matter how profligate California’s state and local governments were – and I am fully prepared to believe they were and are, particularly in light of recent events – blocking one revenue source is like damming one bank of a river, it just shunts the flow in another direction.  Worse for California, by giving non-movers a tax break relative to movers, it gradually develops into an embedded implicit subsidy of the elderly at the expense of the younger, more economically mobile and vital.  It’s torqued the state’s growth, shoved taxation toward more growth-inhibiting forms (like sales tax), and not stopped the bloating of government. 

[In Massachusetts, we have a similar real estate tax cap, Proposition 2½, the brainchild of Citizens for Limited Taxation.  Superficially similar, Prop 2½ is very different because its cap is higher, it's self-adjusting being tied to annual revaluations rather than progressively worse by virtue of being revalued only on transfer, and it allows for safety-valve overrides.  I've posted before about Prop 2½ and will likely return to it sometime soon. – Ed.]

Sounding the same note for thirty-plus years: Barbara Anderson

Take a lesson, I suggested to the Irish audience.  When you don’t tax owned property fairly on a continuous and recurring basis, and instead you rely on transactions to drive revenues (which Proposition 13 did because of revaluation and Ireland currently does with stamp duty), then you give the illusion of low taxes without local accountability.

In fact, that was my recurring theme to the Irish: You can get the populace to accept annual real estate taxes if and only if you tie them to locally autonomous control over visible local services like schools, police, and firefighters.

Indeed, it might be said that strong local real estate taxation is the means by which local government can and must grow, taking power away from an overly centralized national government.

Or their local governments

[Continued tomorrow in Part 2.]

Send post as PDF to

Women, children, and credited cast members first

You have lifeboats in the water.

But you have fewer lifeboats than passengers.

We thought they were enough, for the ship could never sink

What do you do?

Get away from the wreck as quickly as possible?

As reported in the Boston Globe, that dilemma confronts Julia Kehoe:

Julia E. Kehoe, the commissioner of the Department of Transitional Assistance, which oversees state shelters, said the system is “overburdened” and must change to provide services more equitably.

Trying to provide services equitably: Julia Kehoe

[Full disclosure; I worked with Julia when she was executive director of the Metropolitan Boston Housing Partnership.  MBHP does great work, and Julia's good people, so I'm biased. – Ed.]

Key to these programs is the department’s name, Transitional Assistance.  As the Web site says:

At DTA, we provide individuals and families with food assistance, job assistance, cash assistance and emergency shelter.

DTA administers benefits such as Food Stamp Benefits, Transitional Aid to Families with Dependent Children (TAFDC), Emergency Aid to the Elderly, Disabled and Children (EAEDC) and Emergency Assistance (EA).   Because DTA emphasizes transitional assistance, recipients are encouraged to participate in education, training and job search activities to assist in obtaining employment, which helps us all achieve our potential and maximizes our independence.  With our support, our clients are given the tools to improve their lives. 

Basically, you have two choices:

Fill the lifeboats with the first in, and then repel all boarders.

Have a rotation, some in and some out of the boat.

Leo, you’ll have to understand, I’m in the lifeboat

If you’re going to choose a rotation, what rules might you select?

Less than two years after vowing to end homelessness in Massachusetts, the Patrick administration has proposed new regulations that it acknowledges could force hundreds of homeless families back on the street.

Consider me exasperated by the sophist false dichotomy set up in the opening sentence.  Supply is not being cut.  Rather, in forcing ‘hundreds of homeless families back on the street,’ as the Globe puts it, the Patrick Administration is proposing to bring hundreds of other deserving families off the streets. 

The regulations, scheduled to take effect April 1, would deny shelter to families who:

1. In the last three years, had been evicted from public or subsidized housing, or ‘had abandoned such housing’ without good cause. 

2. Fail (a) to meet a new 30-hour per week work requirement or (b) to save 30% of their income. 

[Both sentences rewritten for clarity. – Ed.]

So we have two tests. 

1. Were you in affordable housing and then left it, either because you were kicked out or because you walked away without a good reason?

2. If we have been giving you free housing, have you put the time to use (the work requirement) and put aside the money you’d otherwise have had to spend on housing?

Do either of them seem unachievable to you?  Unreasonable?

I take some convincing

What about these rules?

They also would:

3. Reduce from six months to three months the period families can remain in shelters after their incomes rise above state limits.  [Emphasis added.]

4. Force out families absent from shelters for at least two consecutive nights as well as those who reject one offer of housing without good reason.

5. Deny benefits for families whose members have outstanding default or arrest warrants.

6. [Deny benefits to] those whose only child is between ages 18 and 21, unless the child has a disability or is in high school.  [In our society, 18 and above is a child no longer. – Ed.]

Do any of those seem unduly draconian to you? 

Thought not

Some thought so:

Advocates for the homeless decried the proposal, which comes at a time when more homeless families are seeking beds in state shelters and remaining there longer. This month, the state is providing shelter for a record of nearly 2,700 families – one-quarter of them cramming for weeks at a time in expensive, often unsuitable motel rooms.

Whatever the choices, it’s not easy

“This is not the time to change the safety net,” said Robyn Frost, executive director of the Massachusetts Coalition for the Homeless. “The number of people in need of shelter is like nothing we’ve ever seen. There’s never been such a desperate need for housing, and these changes could be devastating. They couldn’t come at a worse time.”

Don’t mess with my safety net when I’m falling on it

While I understand Ms. Frost’s concern for her constituents, the issue isn’t whether we need more homeless housing – we do – but whether, given the finite supply, we give it to those where it will make the most difference.  Hence, I’m with Ms. Kehoe:

“It is certainly not our intent to be punitive, and we understand the difficulties families are facing,” Kehoe said. “But we are responsible for transforming the system, and particularly at a challenging time, it is absolutely critical that all stakeholders need to work together to make sure that families have the greatest chance of moving out of shelter and poverty.”

And she has the evidence on her side:

While hundreds of families will likely lose their shelter beds, she said the changes would open space for qualifying families, many of whom the state is now paying an average of $85 a night to stay in motels. Last week, more than 630 families, including about 1,000 children, were staying at motels, waiting an average 22 days for a spot at the state’s 59 shelters.

Thus we have families staying in motel rooms – at the state’s expense (average $85 a night, or a whopping $2,550 per month) – because there is no room in the homeless-shelter lifeboats. 

Sometimes the choice is living in a car

By reducing those eligible for shelter, Kehoe said the new regulations would save the state $520,000 this fiscal year and more than $11 million in fiscal 2010. “Given our limited resources, we wanted to encourage people to find housing or stay where they are, rather than encouraging them to come into the system,” she said.

Now are you more willing to push out into the market those who have been evicted from affordable housing, who haven’t used their time in the shelter to work or save a little money, who are staying in the shelter even though their income has risen, and so on?

I haven’t finished using it

There’s also the Law of the Observant Herd: forcing out those who aren’t diligent or who disrespect the benefits they are receiving sends the best possible signal to all those who are wondering which behavior to adopt.

But those who work with the state’s neediest residents said the new “harsh restrictions” will only make it harder for the homeless to find a way out of poverty.

They will make it harder for some homeless; they will make it easier for some other homeless.  A rotation policy isn’t anti-poor.

They said many of the regulations are open to interpretation and risk being applied unfairly if a shelter director doesn’t consider an explanation reasonable.

Keep thinking!

That’s always true of any regulations.  The alternative is to save everybody, which the state can’t afford.

But Kehoe insisted the regulations will be applied fairly and noted they provide exceptions for:

Families trying to pay down their debt

Those who hold jobs that might make them reluctant to accept a housing opportunity too far away

Others who can’t find affordable housing after their income rises above welfare limits.

Hard to argue with any of that.

You think it’s hard to argue?  I’ll show you hard to argue!

She and other state officials said the regulations are part of the administration’s effort to overhaul the shelter system by more quickly moving the homeless into more permanent housing. In 2007, state officials moved the last homeless family out of a motel and heralded it as part of their new strategy to help all of the state’s homeless find permanent housing.

So the state was making progress — then the recession hit, and the demand has spiked.  (Rents are down a little, not enough to make a difference in housing consumption.)  That spike has spurred the state to innovate in pursuit of efficiency:

As part of that plan, the state recently merged the welfare agency’s emergency shelter programs with housing programs run by the Department of Housing and Community Development and is now planning eight regional networks to better coordinate homeless services and housing.

Homeless shelters aren’t affordable housing, although they can overlap in customers and purposes. 

And this month, the state revised the way it pays shelters, holding back thousands of dollars in payments until homeless families are housed.

‘Pay for performance’ should work for shelters as much as it works for the sheltered. 

The state now withholds its final payments for a year after the family leaves the system, as part of an incentive for shelters to extend their services to help keep the families housed.

Our goal, remember, is to get people out of shelters and into self-sufficiency.

“We know the severity of the problem, and we’re trying to provide a comprehensive approach,” said Bob Pulster, executive director of the state’s Interagency Council on Housing and Homelessness.

Pulster (on the left), seeking a comprehensive approach

He and others said they expect to receive millions of dollars from the federal stimulus package, which they hope will ease the state’s growing burden.

But they said federal money won’t stop the new regulations from taking effect – and the imminent changes have Grace Monteiro worried.

The 28-year-old mother of a toddler has been in and out of shelters and apartments for several years. In the fall of 2007, six months after landing a $15-an-hour job as an administrative assistant, she was forced to move out of a shelter because she exceeded the income requirements, which is now an income of $1,578 a month for a family of two.

Ms. Monteiro and her son appear to be the archetypal customer we are trying to help – someone who is teetering on the cusp of self-sufficiency. 

”It’s a catch-22,” Grace Monteiro, with her son Keegan, said of housing regulations for the city’s homeless. Monteiro, 28, has been in and out of shelters and apartments for several years.

So she moved into an expensive studio apartment – she couldn’t find affordable housing in time – but she had trouble balancing the rent with her other expenses.  Within a few months, Monteiro lost her job [What reason? – Ed.] and she and her son moved into a state-subsidized motel room and then back into the shelter system.

She says three months isn’t long enough for many families to find affordable apartments, which are increasingly scarce.

Certainly, there’s no doubt that affordable apartments are hard to come by here.  Ms. Monteiro needs roommates or a sharing arrangement.

As a result, she thinks the new regulations will just encourage more parents to avoid working.

“It’s a catch-22,” she said. “I want to get a job, but I’m afraid to get a job. I don’t want to repeat what happened last time.”

Although I’ve never been homeless, I’m convinced that you are what you live in – and if you’re homeless, you cannot possibly be as effective in your life and your work as if you have some stable housing.

“Because if I don’t have housing after three months, then what? This just makes it harder to do the right thing.”

The right thing is to find a way out of the poverty trap within three months, or manage the lifeboats to give someone else a try to do so. 

Kate, honey, don’t you think it’s my turn in the lifeboat?

Send post as PDF to

My dear, your being down is in the nature of things

“I don’t want downs!” shrieked Lucy.  “I want only ups!  I want to go from an up to an upper up!”

So it is with investors and risk; we’re delighted to take the ups – we even congratulate ourselves on our sagacity and daring – but we become apoplectic at the downs.

Does the word begin with F?

So, it seems, are the editors of the New York Times, who have authored a nothing-but-upper-ups editorial

If you have a 401(k) retirement plan at work, you don’t need us to tell you that you’ve taken a hit in the past year. The really bad news is that the damage to your retirement security is likely worse than what the numbers say on your statement.

Many Americans didn’t have enough savings coming into the downturn.

Okay, stipulating that to be true arguendo, whose fault is it that they don’t?

And employers are increasingly cutting back or suspending their 401(k) match.  FedEx, Eastman Kodak, Motorola, General Motors and Ford, among others, have announced such moves.

There’s also no guarantee that today’s battered 401(k)’s will rebound powerfully.

There’s no guarantee of anything.

People close to retirement don’t have time for a do-over.

Lest those reading the editorial not be themselves close to retirement, the Times wants you to feel afraid too:

I fear the wrath of Times

Even for those still far from retirement, there’s no telling how stocks will perform in the future.

That’s always been the case.  You could have invested your 401(k) in bonds or treasuries.  Or you could have a defined-benefit plan (which was the old model) – but then you face the risk, as my grandfather had it, that your company will go bust before you retire.  He worked for over two decades at the Saturday Evening Post, and built up a very nice pension.  Unfortunately, the Post went under, and with it his pension.  From that financial implosion and several others we enacted legislation – ERISA, the Employee Retirement Income Security Act –to safeguard pension money from plunder or corporate collapse, and then enacted 401(k) because it was a better investment alternative for individuals. 

Here’s Wikipedia’s summary of the history:

In 1978, Congress amended the Internal Revenue Code by adding section 401(k), whereby employees are not taxed on income they choose to receive as deferred compensation rather than direct compensation.  By 1984 there were 17,303 companies offering 401(k) plans.  In 1998, Congress passed legislation that allowed employers to have all employees contribute a certain amount into a 401(k) plan unless the employee expressly elects not to contribute.  By 2003, there were 438,000 companies with 401(k) plans.

Originally intended for executives, the section 401(k) plan proved popular with workers at all levels because it:

Had higher yearly contribution limits than the IRA

Usually came with a company match

Provided greater flexibility than the IRA, often providing loans

If applicable, offered the employer’s stock as an investment choice.

It is, in short, a better mousetrap.

Is that my retirement cheese?

The danger of the 401(k) plan is if the contributions are not diversified, particularly if the company had strongly encouraged its workers to invest their plans in their employer itself. Congress inserted trust law fiduciary liability upon employers who did not prudently diversify plan assets.

Today 401(k)’s are the retirement savings vehicle of choice, because they incentivize savings, are easy to administer, give employers a reliable expenditure stream, and give recipients wide choice in their investment strategy. 

Most people, quite rationally, put their 401(k)’s into equities.  Which go down, as the Times bemoans, but also up:

I want only upper ups!

They could post impressive gains, especially in the near term, from their current low levels. But they could also struggle. The last 25 years was a time of low inflation rates and low interest rates, which boosted stock prices. Going forward, inflation and interest rates have nowhere to go but up, which would be bad for stocks.

This is populist nonsense.  In general, inflation is the young’s revenge on the old for their over-spending.  As the world’s foremost consulting housing financial theorists, Sherlock Holmes, put it:

“If revenge is a dish best served cold,” said Holmes, “then inflation is a dish long marinated.  Inflation is the young’s revenge on their elders for over-spending.  In fact” – he twirled his fingers and the image appeared – “we may express it as a law.”

“Fortunately or otherwise,” Holmes said with a thin smile, “once money was invented, inflation came along with it.  As opposed to pure barter, where commodities and services are exchanged directly – money is always an abstract representation of a unit of value.”

Meaning that the value of money is what you can buy with it.  So inflation, if it comes back – which it will, with a vengeance – devalues debt instruments, increases the value of commodities and equities.  Stock will come back when inflation does – probably before.

It wasn’t supposed to be this way. Over the last several decades, businesses and government used matching contributions and tax breaks to encourage the proliferation of 401(k)’s. They lauded them as a way to harness the market to create wealth and increasingly viewed them as replacements for traditional corporate pensions.

Well, they were.  Indeed, they encouraged people to save, tax-free.  Remembe the Times bewailing that Americans didn’t save enough?  It wasn’t for lack of incentives or vehicles.  Nothing could have been easier that to put away more of one’s paycheck.

My company uses 401(k)’s.  We believe in them; we fund a match. 

In 1983, 62% of workers with retirement coverage had a traditional pension only, while a mere 12% had 401(k)’s. Today, approximately 20% have a traditional pension and about two-thirds have only 401(k)’s.

Because they’re better.  Because defined-benefit is a different fool’s game.  Because there ain’t no such thing as a free risk premium. 

The shift to 401(k)’s also shifted investing risks and responsibilities from employers to employees, but as long as participants generally made money and recovered losses quickly, the risks seemed reasonable.

Seemed?  I know not seemed.  The risks were reasonable.  Investing in a 401(k) didn’t compel you to put your money into equities.  Most companies offered a range of funds, from heavily debt-oriented to mostly equities.  So each investor could decide where he or she wanted to be on the risk curve.\

Don’t say you didn’t have choices

Choices within choices

Now many Americans are inevitably having second thoughts.

Would it be too cynical to say they are now having first thoughts?

Perhaps you should have thought through your actions first?

So far, the cumulative wipe-out of household retirement savings totals about $2 trillion, and no one believes that the downturn is anywhere near over. As a result, participants in 401(k)’s are in greater danger than ever of coming up short in retirement.

Yes, let no one doubt that the global de-leveraging will hit everybody – that’s the definition of a financial pandemic – among them the soon-to-be-retirees of my boomer generation, who always spent as if there would be no tomorrow.

That grim reality calls for an expanded approach by policy makers to retirement issues.

I’m from the Department of Post-Mortem Investments and I’m here to expand my approach

Well, does it? 

Traditionally — and correctly — an important focus has been on lower-income Americans who lack the means to save and tend to work for employers who do not offer retirement plans.

Yes, and one could argue that they are the only part of the spectrum with whom government should concern itself.  Caveat emptor applies to all of us.

During the campaign, President Obama supported a better savers’ tax credit to encourage savings among lower-income Americans.

Fine, although this has nothing to do with the Times’ editorial thesis, that we need to reform how savings are invested and what options people should be allowed in investing their retirement savings.

He also supported universal IRA’s, which would make a 401(k)-like account available to all workers. Those good ideas should be pursued.

Can you hear the approaching but … ?

There are also good ideas for improving 401(k)’s that deserve attention, such as helping people manage their retirement withdrawals so that the money lasts a lifetime.

More should be made of this throwaway comment. 

Money, though conceptually simple, is in its deployment and management fiendishly complex.  Financial literacy doesn’t mean merely understanding how a mortgage loan works or how to balance your checkbook (at least in theory, or via input into Quicken or the like).  We’ve seen that savings precedes borrowing, that buying a home requires consulting help and asks you whom do you trust, and creates opportunities for complex fraud.

“A woman’s handshake is not legally binding.”

Doesn’t the reverse hold as well? 

If the home is people’s largest financial asset, aren’t their retirement savings the second largest?  When vastly wealthy people gave Bernie Madoff their investment money, relying on otherguy due diligence, we clucked at their naivete.  When my grandfather’s savings were wiped out, we patched the funding hole with ERISA.  In turn, he pulled up his socks and got a job at Newsweek, worked a few years longer than he had planned, and go through. 

The wipeout in 401(k)’s has made it clear that it is not enough to get more people to save more. There needs to be a better way to reasonably ensure that a lifetime of savings can’t be undone by forces beyond one’s control.

Like Lucy Van Pelt, the Times wants no downs, only ups and upper ups.

I can’t help those who deny reality

The Center for Retirement Research at Boston College, a leader in retirement policy, is advocating a new savings account — in addition to Social Security and 401(k)’s — that would enable risks to be shared among workers, retirees and the government.

Whoa!

You mean I can share my downs but not my ups?

[The proposal does not leap to the eyes from a quick peek at the CRR’s web site; any reader who can find the reference is invited to email me. – Ed.]

To insulate retirees from the consequences of their overspending, the Times would like to parcel out their risks to:

1. Current workers, who are already paying for employees’ retirement through their Social Security payments.  I don’t know anybody under the age of forty who sees Social Security as anything other than a contemporaneous transfer of taxes from themselves to their parents’ and grandparents’ generation.

2. The government, which is just us in another guise.

Got it?  The pain will be shared among retirees, current workers, and current workers.  Two out of three of these are innocent. 

Two of the three of us are apoplectic

To insulate people of my generation who overspent, they would tax those who didn’t – the young, who will already bear the burden as we dig our way out of this little mess – either directly (probably by taking a payroll deduction at source and funneling into retirees’ accountants – that’ll be popular), or indirectly (by taxing all of us).

“Don’t tax you and don’t tax me, tax that man behind the tree.”

– Senator Russell Long

Send post as PDF to

As we look over the frenetic week that proceed the Emergency Economic Stabilization act of 2008 (”EESA,” rhymes with ‘piece-o”), we can see the Inevitability Effect at work:

With this cast of characters and scorecard for proposals, let’s look at who got what, as reported in a later New York Times:

WASHINGTON — Congressional leaders and the Bush administration reached a tentative agreement early Sunday on what may become the largest financial bailout in American history, authorizing the Treasury to purchase $700 billion in troubled debt from ailing firms in an extraordinary intervention to prevent widespread economic collapse.

In broad terms, the driver won, because many became suddenly sober.

Officials said that Congressional staff members would work through the night to finalize the language of the agreement and draft a bill, and that the bill would be brought to the House floor for a vote on Monday.

Addendum 1: save the optics!

The bill includes pay limits for some executives whose firms seek help, aides said.

This proposal is neither selfish nor ridiculous, so by elimination it has to be reasonable. And we are in a political environment. The CEOs were happy enough to take absurdly big bonuses (hi, Frank Raines! Hi, Jim Johnson!) before, so their brethren should pay the price now. Life ain’t fair, but at least it remembers.

I must be sensible – mustn’t I?

Addendum 2: throw the voters a bone

“Throw me a friggin’ bone, here.”

And it requires the government to use its new role as owner of distressed mortgage-backed securities to make more aggressive efforts to prevent home foreclosures.

This proposal is eminently sensible.

As I understand these matters – I am right about this, aren’t I, court blogger? – I’m two for two!

Addendum 3: improve the deal

Equity stake. In some cases, the government would receive an equity stake in companies that seek aid, allowing taxpayers to profit should the rescue plan work and the private firms flourish in the months and years ahead.

I have no idea who brought this one forward – methinks it was House Republicans – but it’s quite positively clever. First of all, the Treasury plan is a voluntary purchase program, so any bank that can make it without government help is free to do so. Second, should they make the trade and dispose of their assets for cash, the government gets an extra kicker, one that doesn’t cost the affected companies annyithing right now.

It might be piggy, but it’s not a deal-breaker. Verdict: sensible.

My ministers serve me well, even the ones I did not choose.

Addendum 4: trust no one, no one

Oversight. The White House also agreed to strict oversight of the program by a Congressional panel …

One-quarter selfish – if there’s money to be given out, everybody who’s got a voice gets listened to – and three-quarters sensible.

The administration had initially requested nearly unfettered authority to run the rescue program. But in negotiations over the last week, the White House agreed to accept tight oversight of the program by an independent board, as well as a requirement that the government increase its efforts to prevent home foreclosures.

This program is big enough that Congress should have a look-see. They’d probably have had it anyway, but making it explicit costs little.

The administration had initially requested virtually unfettered authority to operate the bailout program.

Even recognizing the need for speed, concentrating that much power with no review or approval process is asking for trouble. Verdict: sensible.

Three-quarters is plenty.

Addendum 5: button down the principal-agent risk

Conflict-of-interest. Conflict-of-interest rules for firms hired by the Treasury to help run the program.

This is easy: sensible.

Those who will serve me may serve no other.

Addendum 6: let the lawyers rewrite the loans

But as they moved toward clinching a deal, both sides appeared to have given up a number of contentious proposals, including a change in the bankruptcy laws sought by some Democrats to give judges the authority to modify the terms of first mortgages.

I understand the sympathies that lie behind this one, but down the path of judicial fiat lies utter chaos, since no one anywhere would ever be considered certain. And why stop at mortgages? What about car loans, student loans? The moral hazard would be out of control.

Some Republicans complained that Democratic negotiators were continuing to push for a change in the bankruptcy laws, to give judges the authority to modify the terms of first mortgages, even though some Democrats, including their presidential nominee, Senator Barack Obama of Illinois, said that proposal should not be added to the bailout.

Score one for Senator Obama.

This has the feel of something that certain members introduced not to win it, but to tell their constituents they tried to win it. Verdict: ridiculous.

Please don’t take me seriously.

Addendum 7: punish somebody, even the unpunishable

Democrats had pushed for a fee on securities transactions, essentially a tax on financial firms, saying it was fitting that they contribute to the cost.

Guess who would wind up paying that securities-transaction fee? Why, everyone who bought and sold stocks – in other words, the consumers.

Look, I’m not paying!

Addendum 8: add affordability any way you can

Affordable housing advocates sought to cushion the blow for long-term housing needs by adding affordability provisions, including this one mentioned in an NCHSA update:

Direction to the FDIC, the Federal Housing Finance Agency (in its capacity as conservator of Fannie Mae and Freddie Mac), and the Federal Reserve Bank to sell foreclosed properties under their control at a discount to states and localities participating in the Neighborhood Stabilization Funding program established by the recently enacted Housing and Economic Recovery Act of 2008.

The key phrase here is ‘at a discount.’ I love affordable housing, and think it’s worth paying social capital for. There’s also the nexus of causation – the people who got into trouble stretched to get into homeownership because there wasn’t enough affordable housing, so we should ease this pressure point. Against that, the discount is unquantified, and if quantified, runs into the harsh opposition that taxpayers are already upset about the proposal, thinking it a bailout.

I think this one was sensible, but a casualty of the extreme speed with which this was enacted. Too bad.

Sorry, better luck next legislative crisis

Republicans were also working [successfully – Ed.] to eliminate a provision sought by Senate Democrats that would direct 20% of any profits from the plan to help create affordable housing. The Republicans want all profits returned to the Treasury.

Let’s assume ‘profits’ means ‘net of losses elsewhere in the scheme.’ If so, this is a much more palatable proposal – indeed, more than likely a very good idea overall, because it costs nothing in the current situation, and only gives away a piece of the upside that most members of the public believe will never occur.

That it got excised is a shame.

A shame, not quite a catastrophe

Send post as PDF to