January 28, 2013
This week’s commentary is a slight departure from our standard format. It’s been a few weeks since we mentioned the fiscal cliff, sequestration and the like. This is due to our collective saturation and the perspective of so many that the problem was solved. Well, we want to provide a reminder or two and throw a few thoughts at you to kick around. We conclude with a quick look at Maine and Illinois.
2013 started with us being told there was a solution to the “fiscal cliff.” Revenues will increase by virtue of a tax increase (or two) on the wealthy (sorry Phil Michelson) and as a result of the payroll tax holiday not being continued (that was not a tax increase but the expiration of the Bush tax cuts was a tax increase – darn semantics!)). The pundits relaxed, the news channels dismantled their fiscal cliff countdown clocks and we were told “problem solved.” The inauguration is passed and it’s time for a reality check: automatic spending cuts go into effect soon and the debt ceiling needs to be solved and not perpetually kicked down the road (although one can argue the Republicans seeming sense of cooperation was simply a clever maneuver to have the Senate finally put forth a budget after 4 years and address spending). There is talk of tax and entitlement reform – let’s see if anyone has the gumption to attack the big issues.
Why the reminder? While we are arguably in a recovery that is, according to some, picking up steam, we need to be cognizant of what some really smart people are saying and what one might expect from tax receipts – at all levels. Let’s start with the fourth quarter of 2012. Tax receipts will be up. Why? Many companies paid bonuses before the end of 2012 or declared special dividends to beat the tax increases. The media was able to provide a sense of what was going on as these practices related to public companies. The real question is how prevalent were these practices across private companies and how will 2013 income and tax receipts be impacted? Time will tell.
We can’t help but think 2012 fourth quarter tax receipts may inject an element of complacency or a view that the economy is stronger than may be the case. The real kicker for tax receipts may come a year from now when 2013 tax receipts are collected. Absent wage increases (which the data does not support), tax receipts for 2013 may be less than budgeted. Will those budgeted tax receipts be there?
Next up is the impact of increased taxes and the expiration of the payroll tax holiday. Let’s assume, for the moment that the rich people don’t change their spending habits. What about the rest of us? According to people much smarter than yours truly, the projection for GDP growth for 2013 is 2-3%. At the recent Barron’s Roundtable, Scott Black of Delphi Management suggested that the expiration of the 2% tax holiday alone can actually cause GDP to decline by .7%! Again, take a look at those budgets and the assumptions contained therein.
Speaking of budgets….
New York released its budget and seems all is good – no new taxes, increased spending, Sandy relief and pensions are highly funded. Oh, did you notice that little provision that allows municipalities to forego their pension contribution – the “Stable Rate Pension Contribution Option.” As the New York Times Editorial page put it:
Mr. Cuomo’s Low-Buzz Budget, Published: January 24, 2013
One of the more questionable aspects of the budget is a provision labeled the “Stable Rate Pension Contribution Option.” Innocent as that sounds, the provision would give local communities the freedom to stretch out their pension obligations to the state by paying less now, and almost certainly more later on. The mayor of Syracuse, Stephanie Miner, describes this as “kicking the can down the road.”
State Comptroller Thomas DiNapoli would have to approve this idea, a decision he should consider carefully. Communities like Syracuse pay pension costs into the state’s $150 billion pension fund, and lower contributions from these communities could make the state plan more vulnerable.
Besides, most of these cities need more help than this revision to the pension plan. Many are struggling with the 2 percent property tax cap Mr. Cuomo and the Legislature imposed in 2011, and there has been little relief from state mandates. Nor does this budget offer these communities anything new in the way of unrestricted state assistance.
Now, perhaps NY thinks it can afford this now given it is almost 100% funded but one has to worry what this looks like in 5 years. A little discipline now just might help preserve the “stellar status” of NY’s pension plans.
Speaking of Pensions….
If only Illinois had passed legislation perhaps Moody’s wouldn’t have downgraded them. We think there may be a bit more to that story. While the below Muni Index review focuses on Maine, our trend for Illinois has spiked from 13 in August of this year to 38 this month. Also, stories like the one in Friday’s WSJ cause us some concern. The cover story discussed how some State Pension Funds are leaning more and more on hedge funds to goose their earnings. It wasn’t too long ago there was quite a bit of noise around where and how pension funds are invested. While it is arguably prudent for long-term diversified portfolios to allocate a portion of their assets to unregulated higher-risk investments such as hedge funds, our concern is that portfolio managers may be tempted to over allocate to these areas in order to improve results and their related funded ratios. Not an unreasonable concern when we have seen several pensions bet (and lose) on rate bets through the issuance of pension bonds.
Last week, following Maine’s downgrade, we provided our clients and trial users the below snapshot on Maine. Check out where Illinois is on the map.
While we generally don’t follow-on a ratings action, we thought you might find the below of interest. Earlier