Four pension myths
Public awareness of state and local governments’ pension struggles is now at an all-time high, thanks to increased media attention in recent years. Though generally a welcome development, there are downsides, as not all pension coverage has hit the mark.
MYTH #1: Pension reform advocates want to cut retired workers’ income.
Reducing pensions for currently retired workers is an extraordinary measure taken only in bankruptcy, and usually not even then. (Ch. 9 municipal bankruptcy is itself very rare, with fewer than 650 filings in history, the vast majority of which were by small special purpose entities, not general purpose cities of any notable size.) Central Falls, RI cut pension benefits for retired workers; Detroit has proposed doing so. But Vallejo, CA did not, and San Bernardino and Stockton do not plan to.
Pension reformers’ goal is to fix underfunded pension systems now, via options such as 401(k)-style accounts, so that future retirees do not face unwelcome reductions in benefits years or decades from now.
MYTH #2: Public pension systems have devoted increased allocation to hedge funds and private equity mostly to enrich Wall Street.
Critics have every right to question alternative investments’ fee structure and opacity, which has created an environment for scandal in New York State, Kentucky, and elsewhere. But the root of the problem lies in politicians and unions pushing for higher and higher benefits, which have forced public pension funds to reach for yield. In 1984, California lifted investment restrictions on pension plans and the result was a rapid increase in both benefits and the total share of the fund’s portfolio devoted towards equities and alternative investments.
At this point, a much more conservative investment strategy, such as one that genuinely reflects the real cost of pensions, would require either significantly greater taxpayer contributions or far more modest benefits.
MYTH #3: Governments have underfunded pensions to pay for frivolous costs, chiefly “corporate welfare.”
Yes, the underfunding of systems’ annual required contribution is a driving cause of their current pension woes. According to the Center for Retirement Research at Boston College, the 126 largest public pension systems in the nation made only 80% of their annual actuarially-required contributions in 2012. But one must first take into account the generosity of benefits. Houston and New Jersey have failed to adequately fund their pension plans due, in large measure, to unaffordable benefit increases granted during the dotcom years.
To suggest that officials did this to fund non-core services is profoundly misleading, as it is in fact pensions themselves that have been “crowding out” room in government budgets for vital services such as public safety and public education. San Jose mayor Chuck Reed said, “The impact of rising pension costs has meant that San Jose can’t hire more firefighters, police officers, librarians, gang intervention workers. These out-of-control costs are why we can’t keep all of our libraries, community centers and swimming pools open.” Faced with a 400 percent increase in pension costs since 2000, affluent Sonoma County, CA has been unable to take advantage of the current record-low interest rate environment to effect critical road repairs.
The proliferation of corporate subsidies began long before pension reform hit a critical mass across the nation. (As the database maintained by the National Conference of State Legislatures shows, almost every state has passed some pension reform since 2008.) There does not seem to be much of a correlation between those states that have been particularly aggressive in pension efforts recently (Utah and Rhode Island) and those which are most generous in handing out corporate subsidies on a per capita basis (Alaska, West Virginia and Nebraska, according to a recent New York Times analysis). Not every government underfunds its annual required contribution. Have states such as New York that have been more responsible in funding their pensions also exercised more discipline over granting unnecessary tax subsidies?
Most importantly, there is significant overlap between critics of corporate subsidies and pension reform advocates. Examples include libertarian-leaning think tanks such as the Reason Foundation and Cato Institute, and, among politicians, Governor Rick Snyder of Michigan (here and here), and, indeed, Rhode Island Treasurer Gina Raimondo. Both policies are in need of reform.
Governments have underfunded pensions because it’s convenient for them to do so, as the consequences of underfunding will not be felt until many years later, and they may thereby get something for nothing. Officials can make promises to workers without worrying about how to pay for them. A more complicated explanation is not necessary.
MYTH #4: Pension reform is unnecessary.
The defined benefit pension plan, still dominant in the public sector, has two essential flaws: it enables sponsors to promise benefits they can’t know if they can pay for and it exposes budgets to the volatility of financial markets. Yes, some governments have been more responsible than others in funding their system, but costs continue to rise everywhere (see, for instance, here, here, and here) and at a rate above which revenues are rising. Remarking on Chicago’s decision to lay off 2,100 teachers and school support staff this past summer, Chicago Mayor Rahm Emmanuel said “The pension crisis is no longer around the corner. It has arrived at our schools.” However passionately unions and retirees cling to the current arrangement, its benefit to taxpayers is dubious.