Policy Options for Public Employee Pensions

By Joseph Coletti
Published on Tuesday, December 20, 2011
SPN NEWS NOVEMBER/DECEMBER 2011

In the most visible fight over collective bargaining and public sector unions on Election Day, Ohioans voted to repeal Gov. John Kasich's signature collective bargaining reform by a margin of 61 percent to 39 percent. National unions and their political supporters poured $30 million into the repeal effort while the law's supporters were slow to act and raised only $7.5 million. The money made a difference, but the 60 percent in favor of repeal matches a poll from early September.

Poll respondents did not see a connection between the law and the reforms they liked, such as moving state workers to 401(k)-type retirement plans. They were less convinced reform would make government more efficient, equalize pay between government and private sector workers, or protect social programs. They also worried that the reform would leave them with less police or fire protection.

Without changes, however, employee compensation threatens to swamp state and local government budgets. Promised pension and health benefits for retirees are the largest contributors to the estimated $4 trillion in total debt owed by states. Pension debts pushed Central Falls, Rhode Island, into bankruptcy and the city had to cut payments to current retirees by half.

Successful models exist. Utah was the most recent state prior to 2011 to move new employees to defined-contribution 401(k)-style plans, but Michigan and Alaska made the transition in the 1990s, and Nebraska has a cash-balance plan that combines elements of both defined contribution plans and traditional defined benefit pensions. Rick Dreyfuss estimated that Michigan has reduced its unfunded liabilities by at least $2.3 billion as a result of its transition in 1997. Real reform is about fairness for state workers, taxpayers and service recipients. 

As Andrew Biggs and Jason Richwine recently found, "the average person who moves into teaching receives a pay increase of almost nine percent, while the average teacher who leaves for the private economy must take a pay cut of over three percent." Taking into account benefits, they state, teachers make $1.50 for every dollar they could earn in the private sector. Government workers are roughly half as likely to lose their jobs as private sector workers. But the median job tenure of a state government worker with their current employer is still just 6.4 years in state governments. 

The Center for Retirement Research at Boston College found that most government workers do not stay with their jobs long enough to qualify for the generous payments that make headlines. For the majority of state government workers, the defined-benefit pension and promised health benefits are no more real than the Easter Bunny.

Our goal with reforming how we reward state government workers is to recognize them as the heroes they are and to save them from the failed promises and bad decisions of politicians. Politicians promised pension payments and health benefits in retirement for state employees, but instead of setting aside money in a prudent way, they made assumptions of large returns on investment that may have been justified in the past. 

In bad times, politicians diverted pension funds to cover budget shortfalls, and in good times, they diverted pension contributions to expand other programs and let market gains fill the gap. As the assumptions of asset growth became harder to match, politicians allowed pension funds to invest in hedge funds, renewable energy start-ups, real estate, derivatives and other risky assets. They also extended pension payment periods to get lower annual payments.

While politicians risk pension assets on alternative investments, they are making government employees, service recipients and taxpayers more vulnerable in other ways, too. Governments across the country have put less money into road repairs and Medicaid services, some have furloughed workers, and others have raised taxes in an attempt to set aside enough money to pay promised benefits.

Politicians are also redefining the defined benefits in ever more restrictive ways, instead of giving workers even the option to move to a 401(k)-type plan. New workers in New Hampshire cannot retire until the age of 65, up from 60. Employees in Delaware and North Carolina must now work for 10 years before they are vested in their pension systems, up from five years before. States that had offered cost-of-living adjustments are cutting back or eliminating those, too. None of these completely forestalls the collapse of a pension fund or a government, as happened in Central Falls, which means that for all the sacrifices government workers make, they are still at risk of having nothing.

When State Sen. Dan Liljenquist got pension reform passed in Utah, he showed how rising pension contributions would limit government services and government jobs. Positive stories of reform are not partisan, Atlanta Mayor Kasim Reed was named Governing magazine's elected official of the year in part because of his ability to move city employees to a defined contribution plan.

Wisconsin's experience with pension and collective bargaining reform this year shows the benefits that accrue to states that actively tackle the challenge. When respondents in Schoen's Wisconsin polling heard how the Kaukauna School District turned a $400,000 projected shortfall to a $1.5 million surplus because of the Walker reforms, they went from 52-45 opposed to 49-40 supporting, a 16-point swing. Respondents who heard of Milwaukee and Kenosha's difficulties balancing their budget because they did not wait for the Walker reforms to pass supported the reforms 46-43, a 10-point swing. 

Here is a simple three-part message.

Allow government workers to invest their own money. This means retirement accounts that they own and know the value of so they are not surprised by a government cutting their checks by half or more. Workers should also have accounts to pay for health insurance and medical expenses after they retire; governments have set aside almost no money to provide these benefits in the future.

Allow government workers to keep their retirement benefits when they leave government to work in another level of government, in a nonprofit, in the private sector, or to take care of family obligations. Defined contributions are the best way to provide benefits to the great majority of state employees who do not stay in one-level of government for 30 years. These people have sacrificed a portion of their lives to help government; they should not be forced to sacrifice a portion of their future incomes, too, just because they do not stay in government for their entire career.

Allow government workers to get more money today. Public school employees in Illinois valued a dollar of post-retirement benefits at just 16 cents of their worth, according to a Stanford University study. If this is true, governments can buy back promised benefits with a small cost today for large savings in the future. Any reform should cover all aspects of employee compensation - pay, benefits and retirement.

We do not need to pit taxpayers against government workers. Government workers are themselves taxpayers. Changing the reward system for government workers can improve government performance, improve services and lower the cost to taxpayers. We must be able to clearly articulate the problem and show that our solutions will work better than the alternative. Despite the setback in Ohio, showing the solutions is getting easier. 

Joe Coletti is the policy specialist for SPN. Write him at coletti@spn.org.

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