Posted by Jeffrey Brown on May 11, 2010
Filed Under (Retirement Policy)
Last week I made a post indicating that the Illinois pension problem was much worse than it appears due to faulty accounting that is sanctioned by the Government Accounting Standards Board. It was one of the most read posts ever made on this blog, and it received quite a few comments along the lines of “blame the politicians.”
This week, I thought I would make a few observations both about who is to blame as well as who should share in the pain of filling the yawning fiscal chasm that faces the State of Illinois as a result of its enormous structural deficits (an issue that is broader than just pensions – but clearly the pensions play a role).
So, who is to blame?
First on the list – the politicians. Indeed, it is almost too easy to blame the politicians – doing so is like shooting fish in a barrel. But it is easy precisely because it is largely true. For many decades, governors and legislators from both parties found it all too easy to ignore pension funding in order to address more “immediate needs” (or, shall we say, “more politically expedient wants”?)
As I have pointed out in a previous blog, my colleague Fred Giertz did some back-of-the-envelope calculations that showed that – in a world in which (a) past governors and legislatures had made the required funding contributions, and (b) these same politicians had refrained from the temptation to use the better funding levels to promise more benefits to state workers – then our pensions would be ever-so-slightly over-funded. Of course, believing either point (a) or (b) is a bit like believing in unicorns – pleasant to think about, but totally unrealistic.
I could stop this blog right here and have most of the readers of this blog cheer for more. But I don’t think it is entirely fair to stop here, because others are also to blame.
Second on the list – the “keepers of the statistics.” This was the focus of last week’s post – namely, to blame the actuaries and accountants who provide political cover to the politicians by the use of inappropriate assumptions for calculating the liabilities. Roughly speaking, the liabilities in Illinois are roughly double the official reports. (To be precise, the analysis by Novy-Marx and Rauh indicates that in 2008, Illinois total public pension liabilities were $151 billion when valued using GASB rules, and $288 billion when using a treasury discount rate. Assets were only $65 billion at the time).
So even if unicorns existed – that is, even if our past legislatures had funded according to Fred’s calculations and resisted the temptation to increase benefits – the State of Illinois would still only have about half the money it needed to be funded according to an economically sound calculation!
Third on the list – a pension governance system that allowed key parameters of the benefit formula – such as the Effective Rate of Interest (ERI) – to be set by a board (e.g., the SURS Board) whose members have a fiduciary obligation to act only in the interest of pension participants, and thus give no voice whatsoever to taxpayers. I can’t help but think that this is one of the reasons that the (ERI) was set as such a high rate for the past 30 years, leading to a situation in which the majority of retirees under SURS got a higher benefit under the money purchase option than through the traditional benefit formula.
Fourth on the list – participants themselves. Yes, I realize that my readership will not like this. But let’s be honest – during good economic times, public employee unions fought hard – and successfully – for pension benefit increases. Increases that could not subsequently be “undone” due to the non-impairment clause in the Illinois constitution. Despite the fact that, at the time when these increases were enacted, pensions were already underfunded. One cannot really fault the unions for looking out for their self-interest (that is what all economic actors are supposed to do in a market-driven system.) But I think taxpayers have a legitimate reason to be irked by the fact that the unions and the legislature “negotiated” higher benefits that are locked-in by a constitutional guarantee without considering the full impact and long-term cost of doing so. Having said this, let me be clear that much of the anti-public-employee and anti-pension rhetoric that we have been hearing lately is misplaced – the vast majority of public employees are simply doing their jobs and want to be paid what they have been promised. But I also think that public employees (yes, I am one too) cannot totally escape our collective responsibility for pushing for more guaranteed benefits without fully accounting for the long-term costs.
So enough of the blame-game. The fact is that our pensions are underfunded. There is a hole that needs filled, and somebody has to share in the pain of filling that hole.
Because many generations of state taxpayers have shared in the gains from our pension deferral, it makes sense that most of the pain should be shared by as broad a base as possible. Thus, fixing this problem through spending cuts and tax increases will have to be the primary solution. But does that mean that participants in our public pension plans should have no responsibility above-and-beyond paying their own taxes? Not necessarily. There is no question that benefits earned-to-date (i.e., accrued benefits) are protected by the constitution. So we don’t need to have that conversation. For those of you already retired, this means you are totally protected – nobody can or will touch your pension benefits (although health care is another story).
And we already know that the state plans to cut benefits for future employees that have not yet been hired. What about benefits not-yet-earned by current employees? I will leave it to the lawyers to sort the interpretation of the impairment clause. But from an economic policy (not a legal) perspective, it seems this is a legitimate issue to have on the table. After all, Social Security benefits (even accrued ones) can be changed by Congress. Defined Benefit pensions in the private sector are exposed to risk (and not fully insured by the PBGC). Why should one particular subset of the nation’s workforce – state and local workers – be immune from sharing in the collective painful decisions we have to make about the size and scope of government?
Having said this, it is equally important to realize that we cannot simply cut future benefits without consequences. Cutting pensions is cutting compensation, and many of our public employers (such as universities) operate in an exceedingly competitive labor market. If we want to continue to attract and retain the very best, we have to compensate them. So cuts in pensions may require spending more money elsewhere (e.g., salaries) in order to be competitive. As I have noted before, I am pretty skeptical of the claims of how much savings such changes can create. But that does not mean they are not a legitimate policy option to consider. Sorry, colleagues.
I’m sure this post will generate a lot of discussion. I’d encourage you to post your comments – I always learn from reader responses. But please, let’s keep the dialogue respectful.