Thursday 21 April 2011

Why don't we see future public sector pensions as ASSETS?

From Citywire:

The current discount rate used by the Treasury to determine unfunded public sector pension liabilities is 3.5%. This puts liabilities at £750 billion. However some pension experts have called for a rate of 1% that would raise the liability to around £1.3 trillion, they claim this is the real liability taxpayers face from public sector pensions.

Clearly, some public sector pensions are merely deferred salary, because in Olden Times public sector workers were paid less than in the private sector but were accruing better pensions, but that's all in the past - from here on in, we are looking at a straight transfer of cash from private sector taxpayers to retired public sector workers in exchange for absolutely no additional work in future.

The accepted figure for the net present value of all accrued pension rights is about £1,000 billion, for sake of argument we can call this annual pension payments of £40 billion to infinity, discounted at a rate of 4 per cent.

So private sector taxpayers see that as a £1,000 billion liability, but remember the Golden Rule - for every financial liability there is a corresponding financial asset (and vice versa); so public sector workers past and present have a financial asset worth approx. £1,000 as well and the two net off nicely to £nil. (For arcane reasons, such assets/liabilities, being akin to 'rents' depress people's net future wealth, but hey).
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On the other hand, we have something called 'land' which people tend to see as 'an asset' rather than 'a liability', but if we follow the analogy, we see that land is not really an asset at all...

Land has little or no intrinsic value, but is bought and sold for the net present value of future rental income which is generated by the location (whether paid in cash or consumed by an owner-occupier is neither here nor - the value is the same).

That stream of payments is exactly like a financial asset, and the net present value of the payments to the lucky recipients is equal and opposite to the net present value of the payments which people will have to make in future (or forego, in the case of an owner-occupier who could otherwise sell his house for cash and live off the interest).

Applying the same discount rate of 4% to a known total land value (i.e. after deducting the cost/value of the bricks and mortar) of about £2,250 billion gives us annual rental income which will be collected privately in future of £90 billion per annum (or £150 billion gross, net of Council Tax, Business Rates, SDLT of about £60 billion per annum etc).

To finish off the analogy - public sector pension payments are in return for no future work by the recipients and can be seen as 'rents'; ground rents are by definition 'rents' and are paid in exchange for absolutely no work done by the recipients in future (location rental values are created by people who live in an area, not the owners of land - if the vendor sells up and moves away, he will contribute nothing to rental values in that area in future - although clearly a lot of people are in both camps).

Something else that pensions and land rents have in common is that the capital value is only 'hope' or 'expectation' value: you might drop dead the day after you retire, in which case your pension was worth next to nothing; and they might build a motorway or sewage works behind your back garden, in which case you have no comeback against the person who sold you the house (provided he disclosed everything he could be reasonably expected to know).
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Or to put it another way, why do people get so upset about the £1,000 billion public sector pension bill (and I am one of these people) but gleefully ignore the £2,250 rental bill, both of which will have to be paid by 'everybody else' for all eternity? Will they both not act as a huge great drag on the economy?

And if you are going to go this far, why not chuck in the £400-billion plus per annum collected in taxes on incomes and capitalise that up to £10,000 billion-plus? How about tapping into the rental income (which is massively depressed by income tax) and use the proceeds to reduce or eliminate taxes on incomes?

11 comments:

Lola said...

Very neat.

I keep telling Mrs Lola's retired lefty teaching mates that they are thieving rent seeking running dog capitalists living on entitlements (aka rents) paid for by the sweat and efforts of the exploited workers. It doesn't make me popular, but if their booze and food is poor quality I don't worry about it too much.

Mark Wadsworth said...

L, ta. I'll cross them off the list of 'people who still talk to you' :-)

dearieme said...

I always make sure to point out to lefty teachers that my primary School had classes of 45 and yet the Principal taught a full class and did his headmastering after we wee things had gone home. It was run during the teaching day by the secretary and the janitor.

So, I elaborate (because they tend to be a bit thick) teachers nowadays have a productivity of about half of what it was back in the 50s. Why, I demand, don't their pay and pensions reflect this steep decline?

Bayard said...

"Clearly, some public sector pensions are merely deferred salary, because in Olden Times public sector workers were paid less than in the private sector but were accruing better pensions."

No they're not. If you are an employer and you want to offer your employees a pension, you have two choices: either pay some money into a pension fund (either yours, or a separate provider's) while the employee is working for you and then, after they retire, draw the money back out to pay their pension, or wait until the employee retires and pay their pension out of the income of the business, keeping the money you would have paid into a pension fund as working capital. All the government has done is chose the latter course. In the same way as the government doesn't have insurance, as it will always have the funds to put right a disaster, it doesn't have a pension fund and hence civil servants' pensions are non-contributary. That doesn't make them a deferred salary any more than any other pension.

L, all pensioners are "thieving rent seeking running dog capitalists living on entitlements (aka rents) paid for by the sweat and efforts of the exploited workers", unless they are living on the principal of savings built up during their working years.

Anonymous said...

Technical question - does changing the discount rate from 3.5% to 1% result in an "increase" instead of a decrease in valuation of liabilities? Wouldn't future liabilities be less if valued at a lower rate?

Anonymous said...

What's the discount for the poor squaddie that's no longer with us. What's the discount for the young policemean/woman who has been blinded by some shotgun weilding maniac.
What's the discount for some matelot who's years spent at sea deprived him of seeing his children grow up.
What's the discount for those that carry out public service for the good of the people.
For a few bob, and in the great scheme of things, that's all we're talking about. Haway ya whingeing curmudgeons.

AntiCitizenOne said...

What's the discount for those that carry out public service for the good of the people?

Same as for those who own unicorns or collect rocking horse shit.

formertory said...

Bayard, you might - just might - have a point if the process were as simple as you describe. Unfortunately, it isn't. Defined benefit pensions are pooled liabilities; there's no individual pot with your name on it.

"Deferred emoluments" or "deferred reward" might be better than "deferred salary". It doesn't quite work in practice, but I'm tempted to suggest "Ponzi scheme" might be as good as or better a term than "deferred rewards". It certainly is for the State pension.

Mark Wadsworth said...

D, go on, how do they talk their way out of that.

B, I mean the individuals are accruing better pensions. Clearly there is very little 'saved up' to pay all this.

Anon, it's easy.
a. If you start with £100 today and interest is 1%, then in one year you'll have £101.

b. If you start with £102 and interest is 1%, you'll end up with £103

c. If you start with £100 and interest is 3% then you'll en up with £103.

So... if I tell you that you're going to have £103 in your bank account in a years' time and ask how much money you need to start with now, you can't answer the question until I tell you the interest rate (also known as discount rate).

So... if I tell you a low interest rate your answer is £102 and if I tell you a high interest rate your answer is £100.

Anon2, nice one, you didn't get the point of the post at all, did you?

AC1, about half of them do useful stuff.

FT, for some reason, the pol's don't talk about the NPV of future state pensions.

James Higham said...

in exchange for absolutely no additional work in future

None of us work for about 8 or more hours of the day. Is that not the same thing?

Mark Wadsworth said...

JH, I don't understand your question, even after having thought about it for a day.