Welcome to Known Unknowns, a newsletter about pension risk—if you squint hard enough.
How much income do you need to earn to be rich?
This, of course, is a really stupid question that confuses stocks and flows. Wealth is what you accumulate over time, which is a function of your lifetime income, not just what you earn in a single year. Earnings tend to increase over a lifetime and peak when we’re nearing retirement, paying for college, and/or caregiving for elderly parents. Approximately 36% of Americans will earn in the top 5% for at least a few years, which thus means that it’s not really the top 5% at all.
And yet somehow we must have an answer to this question, because politicians have promised that only the wealthy will see a tax increase, no matter what we spend. It’s impossible to measure wealth, so picking an income number is simpler (though “simple” does not always mean “right”). Just a few years ago, earning $250,000 a year made you “wealthy.” But now it’s measured at $400,000, which means that the bar increased faster than did the rate of inflation.
Now, even $400,000 annual earners don’t appear to face big earned income tax increases. In fact, Build Back Better actually promises high earners a tax cut. The only income tax increase appears to be on earnings above $10 million. Now, I don’t at all like income cut-offs to measure wealth, but even I think that you should be considered rich if you earn $10 million per year.
Social Security reform is back, and it’s worse than ever!
In the midst of everything else that’s going on, Social Security reform is back on the table—and odds are that it won’t go anywhere, either. But eventually we’ll do something about it, and there are a few features about the latest proposal that are worth noting because they’re especially terrible, and thus will probably inevitably be included in future reform. First off, everyone, the $400,000 is in it! The payroll cap wouldn’t apply to earnings greater than $400,000, or a 14.3% tax for every dollar above $400,000—which is, well, a rather large marginal tax increase. This means that if you earn that much, you face a marginal tax rate well above 50%, and way more if you live in a high-tax state (SALT deduction TBD). However, you do get an extra paltry benefit in return when you retire, so we maintain the idea that it’s not a welfare program.
Not only that, there are benefit increases for everyone! Keep in mind that this is the population facing the lowest rates of poverty. But fear not, because the benefit increases will only last for a few years, so it won’t incur much debt. Or the plan is that we give seniors a higher benefit for a few years and then take it away. Does that mean that when you get your statement, it says $2,000 a month for the next five years, and then $1,900 thereafter? A higher COLA adjustment for a few years and then a lower one? How do you explain that?
Of course not. If there’s one thing that we do know, it’s that pensions are never cut. We’ll default on a bond before a pension is cut, and any benefit increase is intended to be permanent.
This whole “we’ll create an entitlement that will only last few years for budget purposes, but really it will probably be made permanent one day” idea is now a real thing. I know that both parties are guilty of it, but that doesn’t make it acceptable. What’s the point of scoring these bills if they don’t even pretend to be credible?
Fed and unemployment
Inflation is no longer transitory, and we think that the labor market is improving. Now the Fed is getting serious about inflation, or at least it’s speeding up ending QE, which was only supposed to be an emergency policy. If these economic conditions continue, then there could be rate increases next year. Maybe—we’ll see how it goes. Some people are still upset about the 25 basis point increase five years ago.
I’ve seen lots of commentary about how the Fed is turning its attention to inflation instead of unemployment. Now, it’s true that there’s a dual mandate. But I thought we settled in the 1970s on the idea that there wasn’t a clean trade-off between inflation and unemployment. If you ignore inflation, you just get inflation and unemployment. Policymakers have always cared more about people having jobs than prices. But in the 1970s, they became focused on inflation because it made the economy worse for everyone, and it’s very hard and expensive to reduce inflation when it gets out of hand. The only way to get a grip on it is by enforcing some pretty draconian rate hikes. And how did it get out of hand in the past? Well, policymakers thought that they could ignore it and just focus on unemployment instead.
I once met a former Fed Governor during the Volcker era. When they were interviewed for the job, they were asked if they had the mettle to make hard choices that would be unpopular for the good of the long-term economy. And I can’t imagine such a thing happening today.
It’s remarkable how much we’ve learned about monetary policy over the last few decades, as well as how much we’ve forgotten. The fashion today is to talk about doing something years before you actually do it, and expectations are a powerful tool. But they’re only powerful if they’re credible, and anything could happen over the next year that could give the Fed an excuse to go back on its promises. After all, we have an economy that’s now built on low rates, and I can see why the Fed is trying to avoid rate increases.
Eventually, we all need to pay—even if we make more than $400,000 per year!
Until next time, Pension Geeks!