Underfunded state pensions: It’s a matter of fairness

Published 11:01 pm Wednesday, October 7, 2015

Underfunded state employee pension plans loom as a potential economic catastrophe. Illinois’ state pension plan faces a deficit in excess of $100 billion, resulting in the lowest bond rating of any state. Many analysts and investors suspect that the pension system’s liabilities will eventually bankrupt the state government.
The debate over public pensions, I think, has too often focused on secondary matters as opposed to the fundamental problem. State pensions are underfunded today because politicians for decades pushed costs onto future workers and taxpayers. And this is why we need fundamental reform. But let’s first consider some of the other issues that have gotten more press.
First, pension reform is not about reducing the benefits for current retirees or promised benefits for employees. Pension benefits are guaranteed by law, or in some cases the state constitution. Short of state government bankruptcies, the benefits will be paid.
Nor is pension reform about reducing the compensation of public employees. State and local governments should set salary plus employer-paid benefits in order to attract talented workers. I favor small government, but do not believe we should cut corners on the things we ask government to do. Citizens seeking to underpay public employees should remember that we get what we pay for.
Finally, reform is not about the exact form of the pension contract. Many reformers want states to replace their defined benefit plans, in which members are guaranteed certain annual payments in retirement, with defined contribution plans, as the Johnson Center’s Improving Lives in Alabama volume recommended. But this is secondary. Once we set total compensation at an adequate level, employees should be free to decide the level and nature of their pension. Economic theory provides good reasons why employers will offer defined benefit plans. A pension with generous and guaranteed benefits, what could be considered a Cadillac pension, requires larger annual contributions per member, so employees must be willing to accept a lower salary while working.
The public pension debate draws on a lot of complicated pension accounting. But the fundamental need for reform is not based on math. Pension accounting has contributed to the problem, but is not the root cause.
Ultimately state pensions are underfunded today because lawmakers across the country have for decades promised state workers Cadillac pensions while only making the payments for a Chevy. Sometimes this involved increasing benefits but not contributions, and other times lawmakers spent pension contributions on other things. Contributing less than needed for the promised benefits was a great deal for yesterday’s employees, who fulfilled their end of the pension bargain: they made all the contributions they were asked to while they were working. And contributing too little toward the pension helped lawmakers win reelection.
But the deal is bad for today’s state employees and taxpayers. Contributions levels for public pension plans have doubled (or more) in some states with no increase in benefits. Today’s state workers are making the Cadillac payments deferred over the last forty years. And underfunded pensions take an increasing share of current tax revenues as well. Thus schools, prisons and other government services will face cuts to pay for pension promises made by long-retired politicians.
This problem probably has a familiar sound to it. Underfunded state pensions reflect the same political dysfunction as unsustainable Federal borrowing. Allowing politicians to spend money – or promise that it will be spent – without imposing taxes is a formula for a train wreck.
Independent public employee retirement systems have provided the cover through which politicians could promise Cadillac pensions while only making the payments for a Chevy. State employees and taxpayers now and in the future will have to write the checks to make good on these promises. Reform is needed to eliminate the ability of lawmakers to promise or increase benefits without immediately having to pay the full cost.
Today’s underfunded state pensions are the result of yesterday’s politicians making promises they didn’t have to pay for. We need pension reform to prevent today’s politicians from saddling our grandchildren with a repeat of this problem.
Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. Respond to him at dsutter@troy.edu and like the Johnson Center on Facebook.

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About Dan Sutter

I am the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

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