Leadership Needed for Illinois Pension Reform

Posted by Jeffrey Brown on Mar 21, 2011

Filed Under (Retirement Policy, U.S. Fiscal Policy)

This is spring break at the University of Illinois, so I suspect our readership will be down slightly.  Thus, I am going to take the easy way out of this week’s blog post and simply refer you to an interview that I did with the University of Illinois News Bureau.  You can read it if you click here.

Most of the points are ones I have made before on this blog.  But Phil is a better writer than I am, so enjoy!

4 Responses to “Leadership Needed for Illinois Pension Reform”

  • Jack says:

    Hi Jeffrey,
    Just thought I’d chime in here as it is on a similar track to our last conversation regarding who it is that actually contributes to a public worker’s pension plan. First of all this statement, “”Politically, we have the same problem with state pensions as we do with the underfunded Social Security system,” said Brown, a former member of the bipartisan Social Security Advisory Board and a senior economist with the President’s Council of Economic Advisers in 2001-2002.” is a bit of a distortion. You know very well that Social Security is fully funded counting both FICA cash flow and Trust Fund interest income. In fact in most years FICA alone has been sufficient to cover all benefits and the Trust Fund has, as was intended by its designers, been building into a substantial asset reserve fund. That Fund establishes the Social Security program as one of the major investors in America along with China, Japan and the UK. Good to know that our the assets of the system are well invested and can be counted upon to continue to support the benefits of the program into the foreseeable future. I understand that most predictions are that, including Trust Fund earnings and principal, Social Security is fully funded for the next 25 years. Even that mid term horizon can be stretched out to the infinite future with only minor increases in FICA rates or improvement in the economy. You know that FICA only recently went shy with the onset of current recession and high rates of unemployment.
    I’m an optimist and would suggest that even the 2037 target will be pushed back once there’s a little improvement and people start paying taxes again. But I digress.

    We were to focus on who it is that actually is funding public worker pensions and how those pensions might be better structured for the good of the workers and the municipalities for which they work. First let’s re-establish what a pension contribution is. It is a portion of a worker’s total compensation. No more, no less. So the easiest approach is simply to negotiated a total compensation amount with each new contract and have some predetermined portion put aside for retirement on the basis of sound actuarial studies. Of course some other portion is also put aside for health care funding. But it is all part of a total amount. Of course it will be necessary to have strict laws about what is done with the amounts set aside for the pension plan. As you point out in the interview, “According to Brown, a history of underfunding the state’s defined benefit plan has created an unsustainable financial burden for the state.” Now whose fault is it that some former administrations may have absconded with the pension portions of the employee’s compensation plans. Why build a whole new barn just because the horses had been let out by the former foremen of the work place? It would be more productive to arrest and lock up the horse thieves rather than trying to think up some fancy new plan to subvert the efforts of thieves to withhold a worker’s earned compensation even if that is future compensation for current work. You know, retirement.

  • Jeffrey Brown says:

    Jack,

    You state “You know very well that Social Security is fully funded counting both FICA cash flow and Trust Fund interest income.” This statement uses the term “fully funded” differently from its standard use. The definition of “fully funded” as it applies in the context of retirement systems is that the assets set aside to fund the system are equal to the present value of the liabilities (that is, the benefits promised by the system).

    Social Security is NOT fully funded, and indeed was never intended to be. It is primarily a pay-as-you-go system, and a paygo system is, by definition, not funded. Now, it is true that we have the OAS and DI trust funds, but they are nowhere near large enough to cover the present value of liabilities. (I will set aside the debate over what the trust funds mean economically, and for now I will treat them as a fund just like a pension fund). I am traveling and so don’t have time to look up the exact numbers, but EVEN AFTER accounting for the trust funds, the Social Security system is several trillion dollars short of full-funding on a 75 year basis, and something like $13 trillion under-funded on an infinite horizon basis.

    Now, this raises some interesting issues. First, you are correct – as is implicit in your comment – that a partially funded, partially pay-as-you-go system is capable of staying in cash-flow balance in perpetuity. Social Security is not in that situation right now, as we know that the projected income is insufficient to cover projected benefits – virtually right away if you ignore the trust funds and in less than 30 years if you count the trust funds – so virtually everyone agrees that at some point in time we are going to have to raise taxes or cut benefit growth. That is just math. But even then, one could be happy just getting the cash flows back in balance, without trying to pre-fund the system. In other words, we don’t really have to come up with $13 trillion to make the system sustainable – we just need taxes and benefits to roughly equal on a year-to-year basis.

    A more interesting question is — if it is possible to run a system on an unfunded or partially funded basis in perpetuity, at least with adjustments as needed to benefits and taxes — they why do we insist that states fully fund their pensions? Why can’t they run them the same way?

    In short, the answer is that they could, and they have, run them only partially funded. As long as they have enough money coming in to pay the benefits, they could run the system just like Social Security does. There are negative consequences to this (e.g., the passing of the burden to the next generation of taxpayers, the fact that a large debt overhang might discourage drive business formation across state borders, the fact that rating agencies might downgrade municipal debt, etc), but they could do it.

    All this is to say that state pension funds are BETTER funded than Social Security when we compare the assets held to the liabilities. But that simple observation does not mean that full funding is necessarily optimal for either SS or state plans.

  • Jeffrey Brown says:

    Jack,
    One other thought – why build a whole new barn? If I thought the problems with the political sustainability of funding were isolated cases of officials absconding with the money, and that we could address it by throwing the thieves in jail, I might be satisfied to do that.
    But the problems we have with the system are not that people are breaking the law. It is that a complicated combination of political incentives, weak mechanisms for enforcing funding, government accounting rules that stand in the way of transparency, and a host of other problems have conspired to make the problems systemic.

    In other words, even if DB plans are terrific for workers, they are not the only stakeholder I am concerned about. And from the other stakeholders’ perspective (current and future taxpayers), the barn is poorly built.

  • Jack says:

    Jeff
    My reference to officials absonding with the funds was a euphemism, not to be taken literally. Under funding of pensions seems almost routine in our political climate over the past two decades. That’s not theft, but if the pension portion is recognised for what it is, delayed compensation, then there would be fewer arguments to renege on such commitments and there might be less likelihood of under funding.