Public Choice Theory and State Pensions

Good stuff from Josh Barro.  He discusses pension issues and pension accounting in depth, but this struck me as the key takeaway

Another major flaw is inherent in the very nature of pensions: They allow lawmakers to give valuable benefits to public workers (and to placate their unions) today without ever having to deal with the ugly future consequences. Handing out a wage increase, after all, generally requires coming up with a significant amount of money in this year’s budget, which can pose enormous financial (not to mention political) difficulties. Sweetening pension benefits, on the other hand, achieves much the same political end—and while it does increase a pension system’s unfunded liability, that cost is spread across pension payments that will be made for many years. In this way, legislators can please public employees now and leave it to future legislatures to clean up the mess....

Defined-benefit pension plans thus provide lawmakers with both the motive and the means to seriously abuse state finances. All over the country, state lawmakers face enormous temptation to appease government workers now, and let someone else figure out how to pay the bill in the future. At the same time, the complex accounting rules that govern defined-benefit pensions make it easy to cover up the costs of the scheme.

The only way out I see is not just a current fix (which can and often is undone in better times) but some kind of procedural fix, ala what CA Prop 13 did for property taxes, permanently binding the hands of legislators on these issues.  In addition, we really need to see the GASB adopt government pension accounting rules that parallel private standards, though I am not holding my breath on that one.  Of course the ultimate solution is to do what nearly every private company has done -- get out of the defined benefit pension business, and substitute a 401k with employer contributions and/or matching.

  • me

    Yup. In a nutshell, no accountability and ability to postpone damage to future administrations/other people is behind the bind we find ourselves in.

    My favorite proposal for accountability would be that every bill needs to come with per year cost estimates over its lifetime, with the sponsors responsible with their personal property for shortfalls. You'd see more honesty in cost estimates almost immediately 🙂

  • GoneWithTheWind

    I suggest a state law requiring that all state and local workers average pay not exceed the state's civilian average pay. Further that no state wage exceed two times the average pay. In my state the average is $38k. That would mean no state worker, including governors and AG etc. could be paid more then $76k a year and there would have to be a lot of workers making a lot less to avewrage out at $38k. I'm sure the arguement against this would be that with those limits the state wouldn't be able to find workers who would work for that wage. My response is "GOOD"! There is little of value coming from the state and if we could both reduce labor costs AND reduce the BS then we citizens win.

    As for retirement benefits I suggest no guaranted benefits and a flat 6% contribution by the state. No more no less. Allow the worker to contribute up to 9% and let them manage their own account just like we all do with our 401k.

  • Max Lybbert

    When I lived in California, every budget hole was papered over by borrowing from the state employee pension fund. I think they only stopped because they ran out of money to borrow. But I can't for the life of me see any reason for state employees to prefer pensions to something more 401(k)-like (403(b) or 457 plans).

  • James H

    Max,
    The defined benefit pensions are preferred because the benefits are certain, regardless of market performance. And if you're a state employee, they're constitutionally guaranteed as well. Our 401K plans may end up with small gains due to market performance, the risk is all on the individual, no state guarantee.

  • Bill

    Just like every thinking person in the detroit area, where I am from, knew that sooner or later their would be a massive reckoning when it came to pension and pay offered by the big three, so too must people begin to get an inkling that government employee benefits, local, and state, will be altered dramatically.

    It strikes me that the employee unions, just like the UAW, share in much of the blame. Like the UAW, they should have realized that their benefits were too good to last; there wasn't enough money to keep on paying them.

    (Federal employees, actually don't really get much in the way of pension anymore. They do get pretty good leave, thrift savings plan matching (their version of a 401K), and great job security benefits, but the federal pensions that today's younger federal employees qualify for are pretty small and relatively cheap and in any event, if they are not paid out ever nobody could actually say they were planning their entire retirements on them.)

  • MJ

    All over the country, state lawmakers face enormous temptation to appease government workers now, and let someone else figure out how to pay the bill in the future.

    I believe that is what public choice economists refer to as the "time consistency" problem.

  • Noah

    Converting all the defined benefit pensions to defined contribution is the simplest fix because a) private and public employees are in the same boat - the health of the private economy, b) today's employees pay for their pensions and only their pensions, and c) politicians can't kick the budget can down the road promising future benefits,

  • Dr. T

    "... the ultimate solution is to do what nearly every private company has done — get out of the defined benefit pension business, and substitute a 401k with employer contributions and/or matching."

    The federal government did that with most employees starting in the late 1990s. When I became a VA employee in 2003, the retirement benefit consisted of a 401k plan with the government fully matching up to 6% of contributions and 50% matching up to another 6%. If you maxed your 401k, your total compensation went up by 9%. This benefit is similar to what many private corporations offer. The weird thing was that at my VA hospital, only one-fifth of the employees put any of their pay into a 401k plan! (The one-fifth who did were almost exclusively administrators and physicians.) An employee who earned $40,000 a year could have put $4800 into her 401k and got an additional $3600 from the government. $8400 a year for 30 years would build a nice retirement fund. Instead, these workers will try to retire on just their Social Security benefits (that may be drastically cut or gone when they retire).

  • Pat Moffitt

    As someone that worked in the privatization arena--my opinion is the labor inefficiency in the Public sector-the staggering level of over-staffing- is a much bigger problem that the benefit packages.

  • markm

    "The defined benefit pensions are preferred because the benefits are certain,"

    Only if the entity that offered this open-ended obligation is actually able to pay when the time comes. A defined-benefit pension is a long-term debt for the employer, and it's a debt that increases unpredictably with every improvement in medical technology. Beyond that, many states have been putting aside in pension funds too little to pay the expected cost, except under the rosiest of market predictions. With CA's borrowing from the fund, they may have fallen even lower than that.

    And then there's the kicker: CA pensions are a % of the last year's total pay, including overtime. Cops with enough rank and seniority therefore pull a huge amount of overtime their last year, doubling their pay and their pensions. The debt is twice what it was expected to be, and the fund to pay it is far below where it should have been.

  • JonMChe

    While the shift from defined benefit to defined contribution plans in the private sector was driven by the risk reduction to the corporation, more significant it was driven by the immediate cost savings. The reality is that most employees, especially younger ones, greatly underestimate the value of their defined benefit pension. As a recruitment and retention tool, therefore, db plans are overly costly. A 401-k plan generally costs a small fraction of cost of a typical db plan. Unfortunately, it also provides only a small portion of the benefit. The reality is that our society is fast approaching a major demographic bubble of retirees. Most baby boomers that are covered only by 401K plans are saving about 1/4 the amount they need to retire. When they run out of money, the cost of maintaining these elderly citizens will be shifted to the government. The push towards eliminating db plans and replacing them with a 401k is a short sighted public policy. Government needs policies that insure that our citizens are saving enough to retire. Instead we have policies that only look ahead as far as the next election cycle.

  • aczarnowski

    @Dr. T, this is what I call the "transition sucks" problem. Whenever a transition occurs the guys straddling both systems have to run twice as hard to navigate both sides and it sucks.

    The retirement case is especially nasty because every generation since 1900 has had a new transition to deal with:

    individual->depression->new deal->ww2->pensions->401k->?

    The people you mention not putting into 401k, I'm guessing, are the older ones straddling pension/401k and had a very hard time internalizing the transition. I've grown up in the 401k world and it was easy for me to see how to make it work. And now that the transition has reach critical mass, there are groups which recognize some (many?) don't want to manage their 401K and provide that service. Funds also exist now that are internally diversified and/or automate different risk portfolios based on the investor's age.

    Here's hoping .gov lets this system ride for a generation or two before throwing another wrench at us. Of course, we're talking about an organization that still thinks pensions are viable so I'm not holding my breath for rational reactions.

  • IgotBupkis, President, United Anarchist Society

    > n addition, we really need to see the GASB adopt government pension accounting rules that parallel private standards, though I am not holding my breath on that one. Of course the ultimate solution is to do what nearly every private company has done — get out of the defined benefit pension business, and substitute a 401k with employer contributions and/or matching.

    No, the latter is just a goal. The former -- getting the government -- state, local, AND federal -- to use GAAP is truly critical. Most of the chicanery that goes on in government at all levels is based on "funny" accounting practices. If they had to use proper accounting techniques, the light would shine on their folderol all the brighter.

    I find it singularly hilarious that people go apoplectic when someone brings up Enron but can't figure out why government accounting practices are so far beyond anything Enron (or Bernie Maddow) ever could have dreamt of.

    I hear, for example, regular call for "a balanced budget amendment" -- such an amendment would be utterly, completely useless without GAAP. And if you doubt that, just note that New York State has a "balanced budget requirement". Now go look up "Attica Prison" and "New York State Legislature" on your search engine of choice.

    GAAP. Demand it.

  • tomw

    Imagine how much you would have as a retirement nest egg if you could sock away ~14% of your pay. Well, you sock it away, but you get no nest egg. You also retain no ownership nor inheritance rights over that pay. It is called "Social Security", but it is neither socal, nor secure. Congress can take it away totally, or modify the qualification requirements, or change the method of calculating benefits or any other thing they damn well please at the drop of a hat.
    My personal expectation back in the middle '60s was that I would get no SocSec benefits. That it would be broke by the time I reached eligibility. I therefor planned and acted accordingly. I took all the 'free money' that I could get with 401k or corporate savings plans with matching funds, and invested it in whatever was available.
    My suggestion to those thinking of tinkering with Social Security is to make two plans available.
    One with the 'defined benefit'[ha!!!] as it is now, the other a '401k style', personally owned, managed with all rights and benefits thereof. Younger workers get a choice. See which plan they want. If they all vote for the 401k, there goes the problem of funding their retirement. All they have to fund is the lump of Boomers. Get past that, and there won't be another problem of that sort no matter what happens to birth rates.
    Now, what do we do to get HeloBen to turn off the presses and keep the value of the dollar bill above that of sheets of TP?
    tom