Pension Myths Keep Us From Making Badly Needed Reforms
As 2014 brings in new struggles for cities and states to pay for employee legacy costs while still funding the essential functions of government, policymakers on both sides of the aisle are reconsidering how to provide a secure retirement for state and municipal employees in a responsible manner.
Reports estimate total unfunded pension liabilities exceed $4 trillion across the 50 states, and Detroit’s municipal bankruptcy, along with dozens more over the last half decade, are just the tip of the iceberg.
Many thoughtful criticisms have come from reform discussions, but also many attacks built on misconceptions, “straw man” arguments and blatant myths. Here are a few facts about reform:
Fact 1: Bipartisan pension reform is responsible and achievable:
Opponents of pension reform often cite partisan politics and ideology as the driving forces behind efforts to repair underfunded retirement systems, but this couldn’t be further from the reality of pension reform.
Most reform plans proposed by policymakers are modest and suggest a move from highly unpredictable defined-benefit plans, where the state or city government acts like a bank or investment fund for employee retirement, and instead gives employees specific contributions to hold in their own retirement account, much like the 401(k) retirement plans that most private sector employees have.
Fact 2: The status quo is not working and is in need of structural reforms, not tweaks or better management:
The story of how pensions got to $4 trillion in debt is simple and largely uniform across the states. Politicians overpromise benefits to employees in the short term, boosting support from those employees, while pushing the cost of enhanced benefits into the future by underfunding pension contributions.
Pension debt accumulates under this underfunding/overgiving incentive dynamic, and is then compounded by the associated unreasonable investment return assumptions and risky investing that states rely on to make up for pension underfunding.
The servicing and repayment of that debt is crowding out the provision of essential public services, preventing states and cities from making their tax codes more competitive, and even forcing many municipalities (and, perhaps soon, states) into bankruptcy.
Defined-contribution plans force 100% retirement funding every year, taking the decision out of politicians’ hands. Assuming that in the future policymakers will make sound decisions is the formula that got states $4 trillion in the financial hole.
Fact 3: Pension reform is not anti-worker, and does not mean stripping employees of their retirement, shrinking benefits and stagnant pay:
Moving to a defined-contribution plan removes the possibility of future debt accumulation by a state, and making that change doesn’t strip employees of their retirement or even cut their retirement benefits — it protects their nest egg.
What does strip employees of their pensions is municipal bankruptcy. Defined-contribution plans help prevent bankruptcy, and in case it still occurs, those employees’ plans maintained outside of the city’s own finances are safe from bankruptcy judges.
Finally, a pension system free of pension debt means more budgetary slack for employees’ salaries and government services. Pension debt squeezes current revenue without providing current benefits to taxpayers, leading to stagnant public spending across the board, including employee compensation.
Fact 4: Defined-contribution plans mean safe investments with low fees and low transition costs:
Prudent state treasurers, empowered by watchful policymakers, can easily make sure that management fees are low for defined-contribution plans and employees are constrained to a set of secure investments.
Further, the actual costs of switching to a defined-contribution system are minimal, especially once on-paper accounting recalculations of already incurred debt are rightly ignored.
In fact, the low cost of administering defined-contribution plans is one key reason the private sector has overwhelmingly chosen these plans over poorly structured defined-benefit plans. With sound oversight and lawmaking, defined contribution can be safe from undue risk, exorbitant cost, and unreasonable complexity.
The path forward:
Perhaps the most dangerous financial threat to states today is in the area of unfunded pension liabilities for government employees. Pension reform should not be viewed as a story of warring views of government or society, but instead a bipartisan and broad ideological coalition of responsible citizens, watchdogs and policymakers standing up and choosing viable public employee retirement policy.
Divisive myths about pension reform obscure this and distract from the task at hand: protecting retirement security for our public servants while ensuring that government can provide necessary services and maintain tax competitiveness without saddling our children with crippling debt.
This appeared on Investor’s Business Daily February 7, 2014.