Exclusive Interview with Former US Comptroller General David M. Walker

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The Fiscal Grand Bargain: Former US Comptroller General Speaks Out About What’s Really Happening on Capitol Hill

The editorial staff of NAFA Annuity Outlook Magazine and president and CEO of NAFA, Kim O’Brien, conducted an exclusive interview with the Honorable David M. Walker. Mr. Walker served as Comptroller General of the United States and head of the Government Accountability Office (GAO) from 1998 to 2008.  Mr. Walker is also the Founder and CEO of the Comeback America Initiative. As the industry awaits the fallout from the President’s federal budget proposal, along with the anticipation of changes affecting the tax laws surrounding life insurance and annuities, the following interview reveals that we may be waiting a bit longer for any real change to occur.

According to Mr. Walker, the new federal budget proposal is more of a new attempt to get a fiscal grand bargain discussion going again rather than an attempt to influence the fiscal 2014 budget.

Mr. Walker’s responses are consolidated under specific issues presented by the NAFA editorial staff.

Regarding last year’s GAO report, emphasizing the increased adoption of annuities:

“I think there will be increasing interest in the use of annuities, especially when interest rates increase. And the reason being is public policy wants to encourage savings, in general, and payments throughout retirement. Currently, there is considerable amount of leakage out of the system due to individuals spending retirement savings prematurely before retirement and in their early retirement years. Personally, I have two personal annuities for retirement. One of which is fully indexed for inflation and one is indexed at 3 percent a year, recognizing that there is going to be inflation over time, but with considerable uncertainty of how much there is going to be. Most people experience an erosion of purchasing power on any fixed payments over time due to inflation. Interest rates, inflation rates, and rates of return right now are very low. And that’s why I make the comment [that] once interest rates and rates of return increase, you might find annuities of more interest.”

Regarding Fiscal Fecklessness – where is America now and where are we headed:

“Well, for four years in a row the United States has spent a trillion dollars more than it’s taken in. And while deficits have come down, which is good, they’re still too high. And while some steps have been taken to try to deal with our deficits, they have not dealt with the leaky drivers that need to be addressed in order to put us on a prudent and sustainable path. First, they haven’t dealt with social insurance programs, so-called entitlement programs. Secondly, they haven’t done enough to rationalize our healthcare promises and deal with healthcare costs. Thirdly, they haven’t focused on the need to engage in comprehensive tax reform, which will make the system simpler, fairer, more competitive, and generate more revenues. And those three elements are absolutely critical to putting this country on a more prudent and sustainable path. So far little to no progress has been made in connection with these three key issues.”

Regarding the low-interest rate environment and the impact on the financial services industry, such as annuities:

“First, I think that interest rates are artificially low at the present point, due to a variety of factors, one of which is that core inflation is low. Secondly, look at the U.S.’s position as compared to other parts of the world. Thirdly, you have the Federal Reserve’s actions. We are self-dealing in our own debt, which results in keeping interest rates artificially low, in order to try to stimulate the economy and help reduce unemployment. And last, but certainly not least, we have weak economic growth. So I think it’s only a matter of time before interest rates will go up, the only question is how much and how fast. We’ve seen the Federal Reserve just within the last week announce that it’s now debating whether it will continue to provide the amount of stimulus it has been beyond the end of this year. First they had said they would continue through the end of 2014, now they’re reconsidering that. And obviously the U.S. is not an island, so, to a great extent it depends upon what happens in other parts of the world. These low interest rates penalize savers. And a lot of individuals are still somewhat risk adverse. Therefore, many people on fixed incomes are having a difficult time, and these factors combined with higher property and other taxes are a growing problem for seniors.”

Regarding Social Security with Baby Boomers and Financial Advisors:

“I used to be a Public Trustee of Social Security and Medicare, from 1990 to 1995. I think Social Security represents a very important foundation for the retirement income of Americans. It will eventually be reformed to make it solvent, sustainable, and hopefully more savings oriented. The question is when and how. I believe it’s likely that Social Security will be reformed in a manner that the younger you are, and the better off you are financially, the more you’re going to be affected by the changes. The changes will be phased in over time. Changes such as gradually further increasing the retirement eligibility ages, raising the taxable wage base cap, increasing the benefits for people near the poverty level, reducing the replacement rate for middle and upper income retirees, and then hopefully and possibly, adding some type of a supplemental savings account on top of a solvent, sustainable and secure defined benefit program. Social Security is currently underfunded about $11 trillion on a discounted present value basis, of which two to three trillion is backed by government bonds. There are a lot of young people who think they won’t get Social Security. They’re wrong, they’ll get it, the only question is at what age, what amount, and what level of inflation protection.”

Regarding your expectations or key thoughts on the coming new health laws:

“I’m assuming you’re talking about the Affordable Care Act. Okay, first, there’s good news and bad news about the Affordable Care Act. The good news is that it’s intended to cover tens of millions of Americans who otherwise were not covered. Secondly, it’s got certain aspects of it that are intended to experiment with paying for healthcare based upon evidence and outcomes rather than activities. The bad news is that it’s likely to cost a lot more money than the government estimated. The government has never done a very good job of estimating the cost of healthcare programs that it runs. With the exception of Medicare prescription drugs, they inevitably cost a lot more than originally projected. The Office of the Chief Actuary of Medicare estimates that the cost of the ACA for Medicare alone will be $10 trillion in discounted present value dollars more than the politicians claim.

There’s also a significant risk of adverse selection since the penalties aren’t that high. As a result, you could see a significant number of employers dropping their plans, providing their employees additional wages for some of the cost savings, but not all, and encouraging them to participate in the exchanges. If that happens, and young people decide not to participate because the penalties on them aren’t that high, then we could have double adverse selection; adverse selection on behalf of employers and adverse selection on behalf of young people. Obviously the system won’t work, if that’s what happens. Only time will tell.

My personal view is that the government has way over promised on healthcare. We need to step back and rationalize our promises and move more towards a universal healthcare promise that focuses on preventative wellness and catastrophic care. It would be delivered with choice and competition through private sector options, but essentially would have a single risk pool and financing mechanism. Guaranteed insurability; individuals would be able to obtain more insurance if they wanted, at their cost or the cost of their employer or, another party. In summary, I think the government has way over promised and it needs to rationalize its promises regarding who’s covered, for what level of coverage, and with what public subsidy. We’re going to need to impose a budget on how much entitled resources we allocate to healthcare. We’re going to have to start focusing on paying for outcomes rather than activities. And we’re going to have to deal with the controversial issue of end of life, among other things.”

Regarding tax reform and preserving the tax benefits of fixed annuities:

“Here’s what I’d like to see happen; I think we really need to streamline simplifying the tax system so that we eliminate, consolidate and better target deductions, exemptions, credits, exclusions, etc. The three big ones that I think ought to be exempt for individuals are, number one: deductions for charitable contributions; number two: interest deduction for one home, for a mortgage amount up to the maximum conforming loan, which varies by region of country. And number three: reasonable limits for savings and investment, and in the case of retirement, rationalizing the number of vehicles and doing more to make sure the related savings are preserved for retirement and paid out through retirement.”

Regarding the President’s new budget proposal and its components:

“First, I think we need to recognize that the President’s budget proposal is really not going to be given serious consideration as part of this year’s budget process. It’s way late, and the differences between the House and the Senate are great. As a result, they’re not likely to bridge their differences this year. The President’s budget is really an attempt to restart discussions on a fiscal grand bargain. It is more comprehensive than the Senate proposal, and it is intended to try to help bridge the House, Republican’s, and the Senate Democrat’s approach.

The bottom line is we’re in the reasonably early stages of tax reform. Senator Baucus and Congressman Camp, who are chairmen of the respective committees and jurisdictions, Senate and House respectively, have been talking for some time. Their talks have been private and there’s a lot more that needs to be done before we’re going to be in a position to do comprehensive tax reform.

Here’s my view. We clearly need comprehensive tax reform, there’s no question about it. And the only way that the Republicans are going to allow for more revenues, is if it’s in conjunction with comprehensive tax reform, and coupled with meaningful social insurance reforms, and possibly additional healthcare reforms. Likewise, the Democrats aren’t going to allow meaningful social insurance reforms, and additional healthcare reforms, unless they get more revenue. And the only way you’re going to get more revenue is through comprehensive tax reform. So that’s why I’m saying that I really look at the President’s budget, not as a bid to try to get something done this year, but a bid to restart negotiations over a fiscal grand bargain. At best, you’re going to get a framework of agreement, associated with a debt ceiling limit, where the agreement would be implemented, over time. You need to do hearings and public outreach, and have private negotiations before you ultimately enact a final package.

I don’t believe that we’re ever going to get to where we need to be on savings through the incentive approach. I actually believe that one of the things that we ought to try to achieve is an automatic savings element as a supplement to a reformed, base-defined benefit program under Social Security. You would have a base-defined benefit program that would have some inflation protection, but that would have an automatic savings element. That would go into a real trust fund with real investments, real fiduciary responsibility, and liabilities. It would provide a supplemental death benefit, a supplemental retirement benefit, and something to leave your heirs if you pass away before it’s exhausted. And it will allow individuals options as to how to invest, including potentially annuity options. In my view, any related funds should be locked up for death, disability or retirement.

Most economic studies that I’ve seen, whether they were on the left or the right, come to the conclusion that tax-based incentives are not going to work for a vast majority of the population. They may work for those that are well off, but they’re not going to work for a vast majority of the population. And unfortunately, a significant percentage of our population, once they touch the money, they will spend the money, and in some cases, they follow the bad example of the federal government, and spend it more than once.”

Regarding DOL fiduciary standards and misunderstanding in terms of purchasing indexed annuities:

“One of the challenges that exists with the government is that you have a lot of very, very bright, highly educated, dedicated people, who take their job very seriously, and who are really trying to do what they think is the right thing for the public interest. At the same point in time, many times they don’t have a lot of private sector experience, and they’re dealing more in theory and perception. Therefore, it’s always very important to try to, in a constructive way, not in a condescending way, help provide them with opportunities to get a sense of what really happens. Who is involved, how are they involved, what type of information is provided, so that they don’t just rely on perceptions and anecdotes. So they have a fuller and fairer perspective to make informed decisions and not draw on premature conclusions. In most cases, I believe that government should employ a principles and values-based approach to regulation.”

Regarding the Comeback America Initiative:

“The Comeback America Initiative is focused on public education engagement; dealing with federal, state and local fiscal challenges. We also provide assistance to policy makers, on a nonpartisan basis, to try to help them understand ways that our government’s finances can be put in order, which is clearly needed. We specialize in dealing with the public outside of the Beltway in very fact-based, nonpartisan, non-ideological principles and values, solutions-based approach. Privately, inside the Beltway, we try to provide private advice and counsel to key policy makers.

We’re partnering with a number of other organizations to try to increase the likelihood that we might achieve a grand fiscal bargain. Such agreements typically only happen in the odd-numbered years because elections are held on even years. And, Comeback America is focused on trying to encourage the administration and key congressional leaders to engage in representative town hall forums with the American people. We have seen that the people are way ahead of the politicians. They know we’re in trouble. They can handle the truth. They’re willing to accept tough choices, as long as they’re part of a comprehensive plan that they deem to be fair. And the way to determine that is based on principles and values. You can go on our website, keepingamericagreat.org, and find something about the $10 Million-a-Minute tour and see that we achieved unbelievable public support for a broad range of reforms, crossing a number of areas, once we got their buy in to six key principles of values as a basis to frame a so-called grand bargain.

When you’re an investor and you make tough choices sooner rather than later, the power of compounding works for you. When you’re a debtor, or you delay making tough choices, the power of compounding works against you.” We need to make those choices. We need to phase them in over time for a variety of reasons, but we need to make them, so that we can get that power of compounding working for us.”

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