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Pensions Aren’t the Problem

How not to balance state budgets.

Mar 28, 2011, Vol. 16, No. 27 • By ELI LEHRER
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In March 2010, the notoriously divided Illinois legislature passed a major reform in the state’s pension plan that created a two-tier system offering decidedly less generous benefits to new hires. In response, Republicans and Democrats alike patted themselves on the back. “This bill is not window dressing,” declared senate minority leader Christine Radogno (R) in an interview with the Chicago Sun-Times. House speaker Michael Madigan (D), long the state’s major power-broker, agreed. 

Pensions Aren’t  the Problem

AP Photo

For all the self-congratulation, the victory proved hollow. Even after the reforms, most analysts predict that Illinois’s pension system will go broke before 2020. In January, the legislature approved a 66 percent hike in the state’s income tax. While it slightly narrowed a yawning budget gap, the state’s overall budget problems remain, and the retirement system itself is hardly on stable ground.

Illinois’s story offers a lesson to other states looking to rein in employee compensation. Quite simply, pension benefits represent a reasonably small share of overall state spending (3.4 percent in Illinois), not all states have severe long-term funding problems, and state pensions are almost impossible to reform in ways that solve current budget problems. Moreover, there’s a commonsense case that reasonably generous public sector pensions are good public policy. Pensions, in short, aren’t the main cause of state budget problems, and many political leaders trying to bring public sector compensation down ought to focus their attention elsewhere.

Let’s start with the facts: In all, 84 percent of state and local government employees are eligible for defined benefit pensions, and all the states allow at least some workers to retire before 65. (Only 10 percent of private sector workers, heavily concentrated in a few sectors, still get defined benefit pensions.) Although the long-term nature of pension liabilities makes the numbers sound scary—the Pew Research Center has popularized the idea of a “trillion dollar” pension liability gap, and some sources come up with even higher numbers—their actual costs are a drop in the state spending bucket. A lot of revenues also roll in over the long term. Pension contributions, according to the National Association of State Retirement Administrators, represent 2.9 percent of state expenditures, almost exactly what they were 15 years ago.

Meaningful short-term reductions in pension-related spending require overcoming almost insurmountable obstacles. Once workers pass a “vesting date” and become eligible for pensions (most frequently after 5 years on the job and rarely more than 10), states usually cannot change promised pension benefits without a constitutional amendment. According to data compiled by the National Conference on Public Employee Retirement Systems, 10 states, including 4 of the 5 largest, specifically protect public employee pensions in their constitutions, and in another 19, courts have ruled that other broadly worded constitutional provisions provide near-total protection for vested employee pensions. Thirteen other states provide more limited constitutional protections. In all, only 6 states—Maryland the largest among them—don’t provide clear constitutional protections for pension benefits, and, in some of them, case-law suggests that major reforms lowering existing pensions might be subject to a constitutional challenge. (One other state, Nebraska, specifically lets the legislature change pension terms.)

All this means that pension reforms made today will not have major budgetary effects until state workforces have turned over entirely, 40 years from now. These constitutional protections have already had consequences. In New Jersey, legislators straight-out refused to consider Governor Chris Christie’s pension plan on the grounds that it violated the state constitution. Efforts at further pension reform in Illinois and Pennsylvania have also faced constitutional questions. 

For most states—even some with deep fiscal problems—pensions aren’t the leading factor. A study by the Wisconsin Legislative Council shows that only 8 of the nation’s 87 major state-level pension systems have gaps between promised benefits and liabilities greater than 30 percent. (Good stock market performance since the data were compiled means things would likely look a little better now.)

In the end, many states facing very large current budget gaps—New York, Florida, Texas, and Wisconsin among them—have pension systems that are likely capable of paying their obligations indefinitely with only minimal tweaks. Even in California, where absurdly generous public employee pensions have attracted enormous media attention, both of the major pension funds have shortages of around 10 percent that the state could cover pretty easily with some combination of economic growth, tax hikes, and service cuts, if its other fiscal problems were not so severe. 

Given that pension systems are not all that expensive, very difficult to change, and in better shape than some assume, there’s a strong practical case for directing budget cutting attention elsewhere. State and local governments also have a strong comparative advantage relative to private industry in offering pension benefits: State governments never go out of business and can count on rising gross revenues so long as their populations grow. (All states but Michigan grew between 2000 and 2010.) As a last resort, they can usually assure themselves more revenue with a tax increase. 

In principle, therefore, state governments are much better positioned to offer pensions than the typical private corporation and can offer them more cost effectively. Since many of the most common government jobs—firefighter, police officer, corrections officer, regulatory overseer—have no direct private sector analog, the lifetime-with-one employer career path scorned by many in the private sector makes a lot of sense for government employees. The real savings for government are likelier to be found in cutting salaries and other benefits. There would still be political obstacles, of course, but not constitutional ones, and the savings would be immediate and potentially much larger.

This doesn’t mean that states like California that allow office workers to retire at full salary at age 50, encourage “double dipping” (letting employees collect more than one state pension, as happens in Florida) or calculate pensions in ways that guarantee employees retirement incomes higher than their working salaries should continue doing so. If nothing else, letting public employees live high on the hog as taxpayer incomes stagnate is deeply unfair. 

But pensions, all-in-all, have been more a target of opportunity than anything else. States and localities intent on budget-cutting would do well to crack down on “Cadillac” employee health care plans (which cost, on average, more than twice as much as pensions), much-longer-than-private-sector vacations, and high wages paid to mediocre civil-service workers who cannot be fired.

Eli Lehrer is vice president of the Heartland Institute.

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