Tackling the pension “transition” issue
Proposals for fundamental reform of public pension systems around the country frequently have run into one version or another of the same technical objection: closing the traditional system will somehow impose a steep “transition cost” on taxpayers. For example, the National Institute on Retirement Security, which is supported by public pension boards and the financial firms that work with them, issued a widely cited research report asserting that a move from defined-benefit (DB) to defined-contribution (DC) retirement plans would “increase costs to the employer/taxpayer at exactly the wrong time.”
The transition cost shibboleth is effectively demolished in a paper issued today by the Laura and John Arnold Foundation.
The paper’s author, University of Arkansas economist Robert M. Costrell, points out that the Government Accounting Standards Board (GASB) sets standards for financial reporting by pension funds but does not, in fact, determine pension funding levels. Moreover, Costrell points out, once governments close a DB plan to new entrants, GASB does not bar them from basing their amortization of unfunded accrued liabilities on total payrolls of both DB and DC plan members–and not just on shrinking DB payrolls alone.
Given the frequency with which alleged transition costs are invoked as a conversation-stopper by defenders of the pension status quo, Costrell’s paper is a potential game-changer in the reform debate.
As indicated by its title (“GASB Won’t Let Me” – A False Objection to Public Pension Reform) the Arnold Foundation paper focuses on the tendency of pension reform opponents co conflate accounting disclosures with funding policy imperatives. Costrell points out that GASB is in the process of revising the pension accounting rules, known as “statements,” that have been incorrectly cited as grounds for the argument that closing a DB plan requires an acceleration of catch-up payments to close existing liabilities. New GASB pension rules could change the existing annual required contribution (ARC) standard — which, he argues, “should put an end to the false claim that GASB poses an obstacle to pension reform.”
From the wrap-up of Costrell’s paper:
The issue of pension reform concerns the structure of future retirement benefits. This is entirely distinct from the funding schedule for amortizing the [unfunded accrued liability] – a financial policy decision on past obligations. The amortization decision is not altogether different from a state’s decision on scheduling payments on ordinary debt. States have generally proven capable of responsibly scheduling debt service, sometimes with the guidance of the rating agencies. As GASB cedes the corresponding role it involuntarily played in pension funding policy, the states will be obliged to take responsibility for sound amortization scheduling, as they do for other forms of debt.
Pension reform is a separate issue from amortization. These two issues have been conflated by those invoking the GASB proviso for closed DB plans, but this has only sown confusion. This is clearly demonstrated when the reform is structured with amortization payments on total payroll. In this way, the growth in the base for amortization payments is unaffected by the reform, so there is no policy reason for changing the schedule of these payments. If that schedule were previously considered prudent, then it should be continued; if it were previously considered imprudent, then it should be accelerated anyway, with or without pension reform. The funding schedule for amortization is a red herring, irrelevant to the fundamental policy decision for pension reform. Amortization pays for past debts; pension reform lays a path toward a responsible future.