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What to do about state pensions

Yesterday's post on state pension plans emphasized the problems with spinning the state fiscal crunch into a morality tale of greedy public employees and weak-kneed state legislators. That's useful for Republicans who want to score some points against unions, but it's not an accurate description of the situation, and it doesn't get us nearer to solutions. But though the pension problem is a long-term problem and not behind the current fiscal woes of states, and though it's not as big as the health-care problem, it does need to be solved.

If you want to think seriously about how to do that, the Milken report I linked to is a good place to start. They convened a working group including state and local officials, union representatives, experts from the capital markets, money managers, academics, public-sector lawyers and representatives from bond rating agencies to think through ways out of the pension crisis. And they came up with some good ones.

Which you like, of course, will depend on which policies you like generally. There are ideas for raising more tax revenue, for cutting employee pay, for letting private-sector workers buy into pension plans, for creating a "race to solvency" in which federal aid goes to the states that are able to pass the most serious fiscal plans. There are proposals for standardizing how pensions costs are estimated and reported, for instituting multi-year budgeting schemes, and for creating a process that would mimic bankruptcy proceedings without actually declaring bankruptcy. Take your pick.

There's also the obvious prophylactic measure: States need to stop deferring so much of their employee's compensation. The current deal for most state employees is that they get worse wages than they would in the private sector and better benefits. Politicians like to cut that deal because it means they don't have to pay for anything right now. And when the market was making everyone rich, such deals even seemed affordable. But the faith that the market will continually hand you back 10 percent a year is now shattered, and so compensation schemes that relied on it have to be rethought.

Unions might not like that, but nor will taxpayers. There are two sides to deferred compensation: costs later, and savings now. We've been paying our public employees less than we would've needed to pay them in the absence of these pension promises. That means that going forward, we're going to have to pay wages closer to the true cost of our payroll. Public employees are already being compensated worse (pdf) than their private peers, and you can't break pay promises and wildly increase that gap and expect to keep attracting the necessary talent. We're hearing a lot of indignation from people who were happy with the "pay less now" part of the deal but have taken a principled stand against the "paying more later" bit. "Pay the right amount now" is not going to please them, but it's the only viable solution.

By Ezra Klein  | October 13, 2010; 9:31 AM ET
Categories:  Budget, states  
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Comments

Here's a completely insane and crazy idea. How about you move them off of DB plans and onto DC plans? Let public employees assume the risk of their retirement investments the same way most of the private sector now does. Corporations figured out a long time ago that defined benefit pension plans are not viable (and threaten long term competitiveness and even solvency), and most companies have moved off them.

I just love how this simple solution isn't even mentioned. Why? Because DB plans are an incredible deal for participants, and an awful deal for those responsible for financing them (taxpayers). Only in the public sector do these things rage on, because of entrenched interest groups and the fact that they aren't an actual business, they just steal money from the private sector. This is why its so infuriating listening to liberal hacks like Ezra. He doesn't really want to solve the problem, he wants to pretend to solve the problem while preserving the absurd benefits these people enjoy.

Posted by: donopj2 | October 13, 2010 9:49 AM | Report abuse

4 actions.

1. Prevent this from happening again. Outlaw public sector bargaining at the state level.

2. If pensions are to be riskless investments (from the point of the pension recipient), force states to discount pension liabilities at 3%, not 8%, and get true liabilities.

3. Eliminate 20% of teaching positions to return teacher/student ratios to where they were in the 1990s.

4. Pass new bankruptcy reform laws to allow states/municipalities to easily shed existing liabilities.

Posted by: krazen1211 | October 13, 2010 9:50 AM | Report abuse

4 actions.

1. Prevent this from happening again. Outlaw public sector bargaining at the state level.

2. If pensions are to be riskless investments (from the point of the pension recipient), force states to discount pension liabilities at 3%, not 8%, and get true liabilities.

3. Eliminate 20% of teaching positions to return teacher/student ratios to where they were in the 1990s.

4. Pass new bankruptcy reform laws to allow states/municipalities to easily shed existing liabilities.

Posted by: krazen1211 | October 13, 2010 9:50 AM | Report abuse

"I just love how this simple solution isn't even mentioned. Why? Because DB plans are an incredible deal for participants, and an awful deal for those responsible for financing them (taxpayers). Only in the public sector do these things rage on, because of entrenched interest groups and the fact that they aren't an actual business, they just steal money from the private sector. This is why its so infuriating listening to liberal hacks like Ezra. He doesn't really want to solve the problem, he wants to pretend to solve the problem while preserving the absurd benefits these people enjoy."


Yep.

Here in New Jersey the Democrats enacted massive spending hikes in the early 00s. They hiked taxes, as was suggested, but it wasn't enough, so they had to illegally borrow to cover operating costs.

They also increased pension liabilities by offering the union thugs 9% more $. They also didn't set aside money for it, other than by borrowing, so today we have to pay off yesterday's pension borrowing, today's pension payment, and tomorrow's pension borrowing.

Posted by: krazen1211 | October 13, 2010 10:00 AM | Report abuse

krazen,

yes I'm in NJ too and its all in the negotiating. Corzine got a measly couple days furlough if i remember correctly but needed to pay through the nose for it. Christie's basically telling the thugs its just not there and they're having to sit and deal with it. Amazing what one governor can do vs one that's LITERALLY in bed with the union boss and her co-conspirators.

Posted by: visionbrkr | October 13, 2010 10:07 AM | Report abuse

The easy solution for state employee pension plans is to convert them into defined contribution plans. This way the current day politicians bear the costs today of any largess they wish to bestow on the unions.

With defined contribution plans the incentive to defer compensation problems onto the backs of politicians and taxpayers in future years is too irresistible.

You don't need to convene a Miliken conference of public employee lackeys and their academic enablers to conjure up some actuarial and political fantasy solutions. It's quite simple.

What's so wrong about people retiring on what they contribute and the returns on those contributions? Let the state manage the investment pool if they don't want to give employees discretion found in 401(k) plans. But each employee should have a shares similar to a mutual fund in the investment pool based on what they contributed and earned. Otherwise, the taxpayers are playing actuarial and fiscal roulette.

Posted by: ElGipper | October 13, 2010 10:07 AM | Report abuse

Moving new workers onto DC plans is in the report, and implied in my argument to stop deferring compensation (which is what DB is). But it isn't a fix for the current pension problems. You can't take a 50-year-old worker who's been working and saving under a DB contract his whole life and tell him that, too bad, he's now on DC.

Posted by: Ezra Klein | October 13, 2010 10:19 AM | Report abuse

Michael Corkery's brief WSJ report cited in Wonkbook this morning really is worth reading, as is the study the WSJ report cites: "Many of the largest U.S. municipalities are understating the true size of their pension obligations by using inappropriate accounting methods, leading to $574 billion of unfunded pension liabilities, according to a study released Tuesday. [...] One of the study's authors, Kellogg professor Joshua Rauh, said in an interview that current accounting rules encourage pension funds to take investment risks and 'taxpayers are bearing the burden of that risk.'" It's an echo of the "Otherwise, the taxpayers are playing actuarial and fiscal roulette" comment made by ElGipper above.

Pearlstein's WaPo column, which advocates wage cuts of the sort that the UAW and IBEW have already embraced, is also good reading. The Davis-Bacon Act (which artificially inflates the wages of those working on infrastructure projects) and the general minimum wage/hour provisions of the Fair Labor Standards Act (FLSA) ought to be reconsidered. In fact, repeal (or relaxation) of Davis-Bacon provisions might help get infrastructure spending back on track, thereby creating the infrastructure desperately needed to enhance commerce in general.

Posted by: rmgregory | October 13, 2010 10:21 AM | Report abuse

Ezra,

true but you can freeze his or her DB amount as it stands now and go forward with DC arrangements. That to me would be fair and much more fiscally responsible. Heck its what private companies did years ago when they realized DB plans were a financial time bomb.

Posted by: visionbrkr | October 13, 2010 10:27 AM | Report abuse

Actually krazen1211, the pension increases you speak of were put in the early 2000s by a Republican governor and legislature.

Similarly the massive borrowing began under Governor Whitman in the 1990s.

Democrats get a good share of the blame but it's pretty 50-50 here in New Jersey.

Posted by: Hopeful9 | October 13, 2010 10:28 AM | Report abuse

Ezra,

You "implied" that DC plans were a possible solution? Come on, this is the most obvious place to start and you don't even explicitly mention it. If you move all new public employees onto DC plans, at least then you have a finite budget issue that you can quantify and begin to manage (like figuring out how the state can pay the benefits to the 50 year old worker who is due what she was promised). It just doesn't make sense to start searching for more money first. To use one of those metaphors you love: Its like you are on a boat with a hole in it, and instead of trying to plug the hole, you are trying to find a bigger bucket to scoop water out. Start at the root of the problem, its just so simple.

Posted by: donopj2 | October 13, 2010 10:37 AM | Report abuse

"Actually krazen1211, the pension increases you speak of were put in the early 2000s by a Republican governor and legislature.

Similarly the massive borrowing began under Governor Whitman in the 1990s.

Democrats get a good share of the blame but it's pretty 50-50 here in New Jersey.
"

You're right about the governor, I don't think we ever had a Republican legislature.

Whitman was also a complete moron, especially with that 1997 ponzi stunt she tried to pull. You can tack on Tom Kean Sr on this list as well.

Chris Christie has said as much.

Posted by: krazen1211 | October 13, 2010 10:42 AM | Report abuse

Hopeful9,

What are you talking about. There hasn't been a Republican controlled legislature since before I was born and I'm not that young ;-)

http://en.wikipedia.org/wiki/New_Jersey_Senate

http://en.wikipedia.org/wiki/New_Jersey_General_Assembly

Posted by: visionbrkr | October 13, 2010 10:44 AM | Report abuse

Edit: Just looked up the history. You're right it seems, looks like there was a Republican legislature for a good portion of the late 90s.

I have no fondness of those guys either. They also toed the NJEA line.

Posted by: krazen1211 | October 13, 2010 10:51 AM | Report abuse

". . . a working group including state and local officials, union representatives, experts from the capital markets, money managers, academics, public-sector lawyers and representatives from bond rating agencies"

With respect, I stopped reading right there. Talk about the fox guarding the henhouse.

Posted by: Hieronymous | October 13, 2010 11:04 AM | Report abuse

". . . you can't break pay promises and wildly increase that gap and expect to keep attracting the necessary talent."

Glad anyway you too believe the concept of a grand ideal called "public service" is and always was a fallacy.

Posted by: Hieronymous | October 13, 2010 11:10 AM | Report abuse

krazen,

I don't know that that's correct although I'd gladly admit I was wrong if proven so. NJ had a Senate President in Donald DiFrancisco who was a Republican but the majority or state senators and assembly members were Democrats.

Either way you're right, Whitman was horrible and unfortunately her being as bad as she was beget Codey, McGreevey and Corzine.

Posted by: visionbrkr | October 13, 2010 11:37 AM | Report abuse

--*There are ideas for raising more tax revenue, for cutting employee pay, for letting private-sector workers buy into pension plans, for creating a "race to solvency" in which federal aid goes to the states that are able to pass the most serious fiscal plans. There are proposals for standardizing how pensions costs are estimated and reported, for instituting multi-year budgeting schemes, and for creating a process that would mimic bankruptcy proceedings without actually declaring bankruptcy. Take your pick.*--

I guess chopping bloated state budgets and eliminating socialist state services isn't on the table in collectivist America.

I won't feel sorry for any government employee who winds up in the gutter after blowing through everyone else's money.

Posted by: msoja | October 13, 2010 11:38 AM | Report abuse

I'll just weigh in to say that Corzine got 10 furlough days from state workers. That worked out to around a 5% pay cut, and that ain't nothing.

Posted by: MosBen | October 13, 2010 12:51 PM | Report abuse

"I don't know that that's correct although I'd gladly admit I was wrong if proven so. NJ had a Senate President in Donald DiFrancisco who was a Republican but the majority or state senators and assembly members were Democrats.

Either way you're right, Whitman was horrible and unfortunately her being as bad as she was beget Codey, McGreevey and Corzine."

Is that so? I stand corrected then.

I just looked at the fact that DiFrancesco was leader and figured there was a majority Republican senate at the time.

Posted by: krazen1211 | October 13, 2010 1:01 PM | Report abuse

Ezra,

The study you cite to regarding lower compensation for public sector workers utilizes mean income data for comparisons. I suspect, however, that this is incredibly misleading.

For example, the study lists average earnings in the private sector for a professional degree at $152k and for a bachelor's degree at $71k, while in the public sector it is only $88k and $48k respectively.

In contrast, 2006 census data (first I found googling) reveals that median personal income for full time employed persons 25+ (who will usually be earning more than someone younger) with a professional degree was $100k, and with a bachelor's degree was $50k.

Now I, admittedly, am out of my element here, but it seems to me that the study completely ignores the fact that average income in the private sector is skewed by extremely high income individuals that drive the mean up. This is a factor that simply is not present in the public sector.

I would posit that the top 1% of the private sector makes so much more than the top 1% of the public sector so as to overall make the average private sector income be higher than the average public sector income, but that this has absolutely no bearing on whether most public sector employees are under compensated.

Posted by: jcdoerre | October 13, 2010 1:02 PM | Report abuse

"I'll just weigh in to say that Corzine got 10 furlough days from state workers. That worked out to around a 5% pay cut, and that ain't nothing."


It also isn't enough. You do know, of course, that Corzine greatly hiked spending in 2006 and 2007?

Posted by: krazen1211 | October 13, 2010 1:02 PM | Report abuse

"'Pay the right amount now' is not going to please them, but it's the only viable solution"

Not with U6 unemployment over 15%- there is plenty of room for downward pressure on wages in most jobs, even cushy government ones.

Posted by: staticvars | October 13, 2010 1:27 PM | Report abuse

MosBen,

Yes but 7 of those 10 days were able to be re-couped and it also made Governor Christie's job of balancing the budget much harder. I can't believe that was the same guy that worked for Goldman Sachs. Somehow I think they have more brains than that over there.

http://www.newjerseynewsroom.com/state/cozine-major-union-reach-agreement-on-job-furloughs

Posted by: visionbrkr | October 13, 2010 1:32 PM | Report abuse

Why not move from a DB plan to a DC plan?

In NJ, state treasurer Andrew Sidamon-Eristoff said in a dailyrecord.com article that "We looked at it and concluded it would, in fact, impose an additional cost in the near and intermediate term because we'd still have an unfunded liability to address, plus we'd have a new defined contribution obligation. Because of the way accounting works, we couldn't amortize the unfunded liability over a long period of time, and that would increase the actuarially required (annual) contribution. So it turned out to be an expensive option...”

This means the state would immediately need to fund a 401K match to those who switched to the DC plan, and continue fund the employees still in the DB plan. In addition, the DB plan would be stressed with far fewer employees paying into it, leading to greater state contributions to shore it up.

Of course, NJ’s Christie deals with it by simply skipping this year’s $3.1B payment.

Posted by: Pattyo3 | October 13, 2010 4:00 PM | Report abuse

Just one comment, on the graph you put up yesterday showing "Non Health expenditures" basically rising at a pretty flat rate. I think the intent was to show that pension benefit costs were not increasing that much and/or that they were not a huge component of state budgets.

But isn't it true that they haven't risen in large part because they can't rise? By this I mean, health, unemployment, etc have risen so much lately that the states are jumping through enormous hoops trying to keep their budgets balanced. They are doing financial triage since they work within a balanced budget constraint. Instead of keeping the pensions funded, they instead use money for education, prisons, unemployment, etc.

When everything else is cut, and people see their neighbor, a retired fire captain, pulling out $150,000+ per year in pension benefits, they scream and holler. And the general public probably doesn't realize that the state legislature is making things worse by deferring pension funding.

Posted by: cjj2 | October 13, 2010 4:33 PM | Report abuse

"Of course, NJ’s Christie deals with it by simply skipping this year’s $3.1B payment."


Corzine did the same thing.

Posted by: krazen1211 | October 13, 2010 4:41 PM | Report abuse

Pattyo3,

so maybe this is a silly question but why is a match required? Most employers that are doing poorly suspend matches when its possible. I don't think the state of NJ is in any better shape than most employers.

oh that's right the unions would never allow it. I get it.

Posted by: visionbrkr | October 13, 2010 5:52 PM | Report abuse

Just a few points of clarification:

At least in California and maybe elsewhere, you can't legally switch people from DB to DC without their explicitly agreeing to it on an individual level. That's why people talk so much about a new tier of benefits for new state employees.

Also, the state of Nebraska, a very conservative state, switched from DC to a "cash balance" hybrid a few years ago after they figured out that people did such a bad job managing their DC money that it was a "waste of taxpayer resources" to support DC accounts.

Finally, let's keep in mind that the vast majority of people with DC accounts have no retirement security. Public employees are some of the very few people who (outside of the top 1% of private sector workers) actually do. So let's not move to a "solution" that has been a complete disaster in the arena in which it has been tried.

And, on that topic, it's probably most appropriate to say that public sectors workers wages vary within a smaller range. So some lower-level public sector workers make more than their private sector counterparts but most mid to senior level public sector workers make vastly less than they would in the private sector.

Posted by: micahdw | October 13, 2010 7:31 PM | Report abuse

Well, the republican thieves have figured out a new way to steal my retirement. For twenty three years I have worked under a contract that says that at a given age with a given number of years working I get a specified amount of my final pay, or some average of three or five years pay. I went to work accepting that I would get that retirement.

But the City didn't feel like paying anything for the first five years since if I had quit before I had five years in They wouldn't have had to contribute anything, and after that they could just wait and hope that I did something that reduced their required contribution, like die or quit and take a lump sum in lieu of retirement.

So now they want to cut my benefits however they can because they owe $100k or more that they should have been paying all along.

That is theft.

And their answer is a benefits package that only says how much I pay in, but says nothing about how much I get back. If the fund manager gets creative and wipes out my contribution I get nothing.

Obviously if I had a choice between higher pay and a DC pension, I take the higher pay.

The original theory behind health and retirement benefits was that if a company is big enough to benefit from being a statistically predictable group, the benefits for individuals could be higher because of the benefits of being a group. Same with Health Benefits. As long as everybody played fair everybody is relatively happy. But City Managers who get creative with employee benefits MAY get lucky and save lots of money, and thereby keep taxes down. Until, of course, their luck runs out. At THAT POINT they decide that their employees are greedy.

Well, yes, I am greedy. I loaned you money for the last twenty-three years at a specified rate with the agreement that you would pay me back at a specified rate. A contract is a contract. When the pension people play around with my money and get lucky they don't give ME a bonus, they just pay themselves that bonus. When they get unlucky, then they want me to take a pay cut.

So, just for starters, make pension fund managers work for specified salaries, like mid management around here, where you are only guaranteed 80% of your specified salary and have to meet particular goals to get 90% or 100% of your salary.

But pension people don't work that way, do they.

All through his Presidency Reagan refused to agree to the full [pay raises that should have happened to keep up with inflation, for civilians, and therefore also prevented the military, (whom he cared nothing about anyway) to also fail to keep up with inflation. Ronnie's claim was that SOMEBODY had to sacrifice to help balance the budget. How else to pay for hefty tax breaks for the rich while increasing spending on worthless projects like MX Missile and a 600 ship Navy?

So let's be realistic. EVERY plan out there to deal with pension problems wants the people who earned the pensions to give them up because the rich don't want to pay taxes.

Posted by: ceflynline | October 13, 2010 11:24 PM | Report abuse

Nice to see a civilized discussion in which people make a lot of good arguments. Pensions are certainly poised to be the next financial disaster, and we do need to find a solution. I think we should be more radical than just switching from DB to DC (though micahdw's description of the Nebraska experience is a cautionary tale).
Retirement planning ought to have two components; a defined benefit (adjusted for inflation) that cannot be passed on (but cannot be outlived either) but will ensure that someone who is too old to work has enough to live on, even if all other things fail (assuming our society refuses to allow retired people to live on the streets). Beyond that, employees should have investments that they can control that will determine whether they can live the life of luxury, or not much beyond the minimum. But what they've saved can be passed on to their heirs, which would give people the incentive to save and not be profligate spenders in their old age.
But why do private employers need to provide such amenities at all? I think the state (Feds) should provide the defined benefit (through social security, though benefits probably need to be boosted a bit), and private individuals should do their own savings (with people who don't want to take the responsibility being allowed to invest in state or non-profit run plans who would invest their money on their behalf). As employers should not be saddled with the responsibility of providing health care, neither should they be forced to provide for their employees retirement (which would make it easier to hire new employees).
Though having the state provide for retirement is socialistic, it should do so in order to make capitalism work better. Because retirement plans are difficult to compare (what level of DB is equal to what DB?), in many cases pensions cost employers much more than employees give them credit for (so the market is not efficient). By having all compensation in cash (which employees could choose to save for retirement, buy an additional annuity, or spend), employees could compare offers from various employers more intelligently, and the details would not be hidden in the benefits package. Public sector employees should make less than their private sector counterparts, which is why it is public service. They should not get credit for earning less (the sacrifice of working in the public sector) but actually have such a lavish pension that the actual cost of their employment is higher than the private sector. When public sector employees actually do make less than their private sector counterparts, they should get credit, which I hope would be attractive to service oriented people. Paying all compensation in cash would also force politicians to pay the costs of the contracts they negotiate, so they couldn't get credit for deferred benefits their successors are forced to pay.

Posted by: kjames196 | October 13, 2010 11:48 PM | Report abuse

Who here wants to deny a 55yo who's put in 35 years of backbreaking labor as a sanitation worker, or a 55yo cop or firefighter who's put his/her life on the line every day, a pension on which he/she can live?

Not I. If you can live with it, you're a Republican.

Posted by: RoughAcresDOTus | October 14, 2010 4:26 AM | Report abuse

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