Opinion

The Great Debate

The truth about pension reform

By John Arnold
February 21, 2014

This article was written in response to “How should John Arnold approach pension reform?” (February 16) by Felix Salmon.

Felix Salmon’s recent post about my involvement in pension reform and Mayor Chuck Reed’s efforts in California contains serious mischaracterizations.

Salmon repeatedly claims that my wife, Laura, and I and our foundation, LJAF, “support plans making it easier for governments to default on existing promises.” Nothing could be further from the truth. We strongly believe that pension reform should not aim to cut or eliminate benefits, and we believe equally strongly that workers deserve to be a part of a fiscally sound, responsibly managed retirement savings system that provides a path to retirement security. Our communities need a simple, transparent system that holds governments accountable to pay for promises to workers. The current system falls far short of this goal. State and local governments have accrued at least a trillion dollars in pension debt, which has led to benefit cuts in 48 out of 50 states. It is unfair to workers to place them in a system where governments’ failures to fully fund retirement promises can necessitate unexpected benefit changes. For the past three years, we have worked to protect workers by encouraging governments to responsibly address their pension problems through reforms that are comprehensive, sustainable, and fair.

In the interest of furthering constructive debate based on facts and not rhetoric, I offer specific comments on Salmon’s recent blog post.

Insofar as there’s a pensions problem, it’s in large part a function of how labor negotiations work in the real world. Local governments, operating on a tight budget, can’t offer the kind of pay raises that the unions demand — and so the unions accept juicier pension benefits in lieu. The present value of the pension benefits is invariably larger than the amount of money the unions would accept as a simple raise — but so long as the current government doesn’t need to pay anything, both the government and the unions are happy. The unions get valuable rights for life, while the government gets to leave for its successors the question of how to pay for them . . . None of this will be easy: the whole reason why pension obligations started ballooning in the first place was that local governments didn’t have the money to hand out pay raises. So the unions will push back against these ideas: they like any system which makes it easier for them to accrue valuable benefits at negligible up-front cost to the government.

Well said. I could not agree more. We argue in LJAF’s solution paper that the structure and complexity of the current system facilitates this irresponsible behavior.

So before we start talking about allowing governments to default on their pension obligations (which is the goal of the California ballot initiative being supported by Arnold)…

This is an absolute mischaracterization of Mayor Reed’s initiative — one that I would have expected to come from union propaganda. The initiative (see the text of it here) explicitly honors and guarantees the benefits earned for work done to date. The only question here is whether the employer and employees should be able to negotiate retirement compensation for work that is not yet performed. In other words, does an employee who was hired yesterday have the guaranteed right to earn pension benefits under the same formula for all future years of service? Under Reed’s proposal, cities in California could negotiate with employees, through the collective bargaining process, to change retirement compensation for future service just as they would do for salaries or health benefits. That change would have no effect whatsoever on benefits that have already been earned.

Make sure firstly that pension plans are funded, or on a path to get that way, and secondly that any future pension promises are funded as well — that an actuarially-derived sum of cash is put into pension funds whenever a local-government employer makes a pension promise.

We wholeheartedly agree. LJAF has published numerous policy papers and made many public presentations that call on governments to fully fund their promises to workers. But we all must recognize that this is a big task, and it becomes more difficult each day that governments fail to address the problem. Most governments are already struggling to keep pace with current pension payments, and, in many jurisdictions, payments are scheduled to grow faster than the economy in the coming years. CalPERS is a timely example. The pension fund board recently voted to both raise the rates it charges participating cities and to increase the state’s payment by an estimated $1.2 billion annually. Even though this was a relatively minor change to members’ anticipated life expectancy, the cost is large — CalPERS estimates that cities could see their rates increase by as much as 9 percent of payroll, and the state’s annual payment is scheduled to increase by more than 30 percent. As you might expect, the CalPERS board and city leaders had serious concerns about the negative impact that the increase will have on local budgets. But this is the harsh reality of paying down the accumulated pension debt — communities are going to have to pay a lot more over the coming decades to dig out of the current hole.

Most cities and states around the country do not have a plan to manage the cost uncertainty associated with the pension plans they sponsor. Instead, many leaders say they will deal with it when the time comes. Yet this approach is exactly the reason why there have been significant benefit cuts and budgetary problems. Mayor Reed’s initiative, on the other hand, would actively push cities in California to create non-binding plans to responsibly fund their benefit promises. Look at the language of the initiative. It “requires government employers whose pension or retiree healthcare plans are less than 80 percent funded to prepare a stabilization report specifying non-binding actions designed to achieve 100 percent funding within 15 years.”

Finally, start working on making local-government pension plans more portable, so that people don’t feel forced to stay in the same town and the same job for decades, and so that people who work for local government for five or six years can leave their jobs with some improved retirement security.

We agree. We do not think it is fair to an increasingly mobile workforce (both among careers and cities) to have retirement plans that are not portable. However, this effect is not limited to those who only spend five or six years working in the public sector. Under many current plans, workers do not earn a meaningful benefit until they have worked for 20 or 30 years in the same job and location. Put simply, the current structure harms the retirement security of a majority of workers who leave before reaching their plan’s specified retirement age.

To get a better understanding of this effect, I encourage you to read a recent paper by LJAF’s Josh McGee. Additional resources on this topic are also available at TeacherPensions.org.

Again, it’s easy to draw attention to outliers — the handful of municipalities which have literally gone bankrupt, and where pensioners are reduced to the status of unsecured creditors. The argument you hear from the pension reformers is that if we don’t take relatively modest action now, there will be a much more drastic reckoning — involving a spate of bankruptcies — down the road. They might be right, but this is the point at which they start to sound like Meredith Whitney.

They say you only find out who is swimming naked when the tide recedes. Certainly, the cities that have gone bankrupt have had other factors in play. But the gist of Salmon’s above statement is that we shouldn’t worry about the problem until a large city other than Detroit goes bankrupt. I disagree. If you wait, it gets harder and harder to meet the goals that Salmon and we articulate — properly funding retirement plans going forward and catching up on the deficits from the past. And the longer jurisdictions wait, the more likely they are to have to change the rules for those who are currently working or retired.

The truth of the matter is that rising pension costs have already resulted in significant consequences for workers and state and local budgets. The current system continues to push a huge amount of the cost for past service into the future, leaving plans and workers vulnerable to future cuts. Not all jurisdictions will face bankruptcy, but letting it get to that point — or even to the point where workers have to bear further unexpected cuts — is irresponsible.

Comments
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Arnold is outright lying about unions grabbing extra pension benefits for the large majority of public employees. The plans were formed around 1948 by reworking older plans. Most were trimmed around 1977 as a result of the inflation crisis. Many were again trimmed in 2011. Maine, Vermont, Massachusetts and NH ran off single party, synthetic bankruptcies against their state and municipal employees. Contract law, pension law and bankruptcy law were ignored during the 2011 changes. The 1977 changes were implemented using lawful methods. The plans are not richer than 1948, they are much devalued. Taxpayers and bondholders were spared any sacrifice in the 2011 pension impairments. There is no obligation to responsibly fund state and municipal governments, tax cuts are always in style. New employees look upon the pension and health care plans as counterfeit.
State laws are pretty much worthless in protected vested pension rights. The new people would prefer a combination of a paid up annuity, social security and 401K to replace bogus pensions. They would rather be private contractors so failure to fund would mean loss of services to the government unit. People are barely able to govern themselves. They are completely unwilling to finance government units. You can see examples of financing failure every day in any newspaper of your choice anywhere on this planet. It is called devaluation, inflation, expropriation, impairment, capital flight, reform and restructuring. Tax cutting comes at a high price.

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