The nomination of Mitt Romney as the Republican candidate to the White House may bring a lot of attention to the US pension fund industry. If he wins the election on 6 November, he could introduce a partial privatisation of Social Security, the compulsory insurance programme funded through payroll taxes. The first president to talk about privatising it was also a Republican one, George W Bush, but his proposal went nowhere.
Now the idea has been brought up again by the House budget chairman, Paul Ryan (Republican, Wisconsin) with his ‘Roadmap for America’s Future’, and if in November Republicans conquer the Senate, besides keeping control of the House of Representatives, the debate about privatisation could gain centre stage.
Romney does not mention privatisation of Social Security in his official programme. He only proposes “a couple of common sense” adjustments to put the programme “on the path of solvency and ensure that it is preserved for future generations”, promising that he “will not raise taxes and will not affect today’s seniors or those nearing retirement”.
The two steps, affecting only “future generations of seniors”, are a “slow” increase in the retirement age “to account for increases in longevity” and a “lower” growth rate of benefits “for those with higher incomes”. Ryan’s plan goes further. It “offers workers under 55 the option of investing over one third of their current Social Security taxes into personal retirement accounts, similar to the Thrift Savings Plan (TSP) available to Federal employees”. It also “includes a property right so they can pass on these assets to their heirs, and a guarantee that individuals will not lose a dollar they contribute to their accounts, even after inflation”.
The TSP is a voluntary defined contribution scheme. Established by the US Congress with the Federal Employees’ Retirement System Act of 1986, it is the third retirement pillar for 4.4m members (on top of Social Security and a defined benefit plan), and it offers six simple and low-cost funds to invest in. In March, Ryan endorsed Romney as the GOP nominee. Just two days before his endorsement, Ryan led the House to unanimously reject president Barack Obama’s 2013 budget plan, so he is quite powerful and Romney will have to take his proposals into account.
On the other hand, Romney must be careful not to give more ammunition to his critics who portray him as the typical “one percent” Wall Street manager whose interests are opposite to the “99 percent” of Americans. His critics focus on his role at private equity firm Bain Capital, where he started the first fund in 1984, generating an outstanding 61% average annual return. Bain relies little on pension fund money, raising most of its capital from foundations, endowments, family offices and wealthy individuals.
But US public and private pension funds account for about 42% of all private equity investments, according to the Private Equity Growth Capital Council in Washington. Private equity allocations have been favoured as a means to achieve higher returns, but this trend may slow as performance has not met expectations and also because of the political attacks on Romney that draw attention to private equity buyouts and the alleged culling of jobs. Public pension funds, in particular, are very sensitive to these issues and they are already on the same page as Obama in criticising the compensation of private equity managers - 20% of the profits from investments or carried interest - and how much they pay in taxes.
Carried interest is taxed the same as capital gains at a 15% rate, rather than the 35% top rate that applies to regular income. Thanks to that, and to wise financial planning, Romney ‘only’ paid a 13.9% tax rate in 2010 on income of $21.6m (€16.5m), as he has disclosed under pressure from rivals, and he will certainly come again under attack from the Obama campaign. It is proposing the so called ‘Buffett rule’, a measure “to ensure everyone making over $1m a year pays a minimum effective tax rate of at least 30%”, in order to “alleviate income inequality between the top 1% of Americans and the remaining 99% of Americans”. If Obama is confirmed at the White House and his tax plan is approved, this will affect not only Romney but the whole financial industry.