Friday, June 27, 2014

The Public Pension Problem

It is difficult to overstate the problems now facing public employee pension plans in American cities and states.

More than 80 percent of government workers are covered by defined-benefit programs that guarantee retirement income based on years of service and salaries at the ends of careers.  I have read estimates that public pensions average 87 percent of final years' salaries, which sounds high to me but may be true.  In any event, when government workers retire, usually at younger ages than workers in the private sector, they receive guaranteed pensions and health care benefits for life.

The situation is very different for private-sector workers.  The number of companies offering defined-benefit retirement plans has plummeted since the 1980s.  According to the Bureau of Labor Statistics, by early 2013, only 18 percent of US workers had such plans.

There are several reasons for the disparity.  One was the federal enactment of programs like IRAs, Keoughs and 401k plans that encouraged workers to set aside money for their own retirements and allowed companies to substitute 401k matches for full-out pension programs.

Another was the decline of manufacturing in the country and, with it, union employment contracts with negotiated retirement benefits.

Third was the change in employment patterns.  People now change jobs and careers frequently.  Even if companies offered retirement benefits, few workers would put in the 30 years it took to get the gold watch and pension.  And many companies would be sold, relocated or go out of business during the same time period.

None of these changes occurred in public employment.

Nationwide, it has been estimated that cities and states have underfunded their defined-benefit employee retirement plans by as much as $4 trillion.

A public union protest in Trenton this spring
A quick canvass of the situation in one state, New Jersey, gives a general idea how the problem arose.

Every New Jersey governor and legislature for the last 20 years has acted to undermine the stability of the state's pension commitments. Some of the early missteps:

         -- In 1992, as stock markets rose, the valuation of pension funds was switched from book value to market values, making the funds appear to be 125 percent funded instead of the previous 100 percent.  The state also adopted a more optimistic assumption -- that invested assets would return 8.75 percent annually instead of the previously assumed 7 percent.  Accordingly, contributions were cut by $1.5 billion over two years.

         -- In 1994, the state stopped pre-funding retiree medical care and drew down previously accumulated assets to pay current claims.  It also gave itself 34 years to bring contributions back to necessary levels, cutting funding another $1.5 billion over two more years.

        --  In 1997, the state issued bonds to fund its pension contributions, effectively funding one year's obligations with future annual commitments starting at $90 million and rising to $550 million.

        -- In 2001, the governor and legislature unilaterally increased benefits for past and future retirees by 9.12 percent.  This was done without collective bargaining and with no real planning.  Its apparent purpose was to curry votes and campaign contributions from public employee unions.

Since 1997, no year's pension allocation has approached the level needed to cover promised payouts. From 2001 to 2005, virtually no money was paid into the retirement system at all.

As the funding failures stacked up, actuaries raised their recommended annual allocations:  In 1998, the amount was about $480 million; this year it's almost $4 billion.

The usual political procedure has been to underfund the obligations in a given year while promising bigger contributions in subsequent years as the New Jersey economy grows and tax receipts go up.

Unfortunately, the economy never grows enough.

Then, when the economy fails to grow, another new future commitment is made and then abandoned with new promises for greater funding in coming years.  This is what is known as "kicking the can down the road."

The current governor, Chris Christie, committed himself and followed through on making the highest (but not nearly high enough) public pension allocations since the 2008 recession.  Now, though, he has backtracked because -- surprise! -- this year's tax collections were lower than expected.

For the coming year, Christie proposes to allocate $681 million, enough to cover the year's payouts, but not the rest of the pledged $2.25 billion to rebuild the funds.

(Remember, the actuaries are now recommending annual payments approaching $4 billion.  Next year's state budget is about $34 billion.)

Democrats have countered with proposals to raise $1 billion with increased taxes on high earners and businesses and to cut the state budget by $200 million.  Christie has vowed to veto any tax bills.

Meanwhile, retired public employees seem to be winning their court case demanding reinstatement of cost-of-living adjustments to their benefits.  (In 2011, the state ceased COLA adjustments, promising to resume them when the state's pension investments covered 80 percent of anticipated costs.)  Even with low inflation and interest rates, it is estimated that COLAs would cost $250 million a year.

None of these groups has the faintest idea what to do in the next fiscal year, when New Jersey is supposed to budget even more for public employee pensions.

The result of all this is that New Jersey's state pension programs are now 57 percent funded with $50 billion in outstanding unfunded liabilities.

New Jersey is a high-tax state, like California and New York but without the nice weather or a world-class city.  In recent years, two people have moved out of the state for every one who has moved in.

The state economy is growing more slowly than other states', and nobody seems to have a good idea for improving the situation.  Increasing taxes won't help, but neither will cutting funding for education, road maintenance or the highway patrol.

It's a big, big mess.

Later:  Can anything be done?

No comments:

Post a Comment