Center for Business & Public Policy
Collaborative blog exploring the relationship between market forces and public policy.

Like millions of Americans, I was deeply shaken by the horrible tragedy that unfolded at Sandy Hook elementary school in Newtown Connecticut one week ago today.  As a father, as an American – simply, as a human being – I was horrified by the thought that anyone could be capable of gunning down innocent and helpless children.  My rage toward the killer was outweighed only by the terrible sadness for the children and deep sympathy for their families.

As the hours and days have gone by, however, my raw emotional response has slowly – if not fully successfully – made some room for my inner economist to begin to examine the situation from an analytical perspective.

Today, Wayne LaPierre, the head of the NRA, stated that “the only thing that stops a bad guy with a gun is a good guy with a gun.” This is a provocative statement, so I thought it was time to examine this issue more closely.

So let me ask a simple question: “Would America’s children be safer if we had more guns, or fewer guns?”

I would like to assume that, with the exception of a few sociopaths, everyone wants our children to be safer.  I do not subscribe to the extremist rhetoric from either side that assumes they are the only ones with the moral high ground and that the “other side” is somehow anti-kids.  Rather, I think both sides agree on the goal – to keep our kids safe – but have a very different view of how to get there.

But who is right?  Would our children be safer with more guns or fewer guns?

To provide some insight, I would like to adapt a simple model that is used to discuss tax policy (stay with me here!) – the “Laffer curve.” (Click here for information on the Laffer curve). 

If there were zero guns available in the U.S., then by definition there would be zero gun-related deaths.  Starting from zero, as the number of guns increases, the frequency of gun related deaths would surely rise, at least initially.  But it probably would not rise forever as shown in this graph.

Why?  Consider the other extreme – the vision of the NRA – where virtually every citizen was armed.  Teachers, professors, airline pilots, nurses, truck drivers, accountants … everyone.

According to the NRA, in such a world, criminals would be reluctant to commit a crime because they know that they would be putting themselves in grave danger.  Or even if they did, an armed good guy would stop them.

What this means is that if gun violence is low at low levels of gun ownership, and also low at high levels of gun ownership, then there must be a horrible “peak” in between where the number of gun-related deaths is at its highest (the peak).

We have over a quarter of a billion guns in the U.S. The question is whether this is above or below the peak.  If it is below the peak, then more guns cause more gun-related deaths, and deaths would decline if we had more effective gun control laws.  In contrast, if we are above the Peak, then small decreases in the number of guns can actually cause more deaths.  Relatedly, if we are above the Peak, then increasing the number of guns can reduce the number of gun-related deaths.  This is what the NRA seems to believe.

This is a simplistic model.  But it does provide an important insight: theoretically, gun control could make us safer or it could make us less safe.  Gun control advocates are implicitly assuming we are to the left of the peak.  Gun rights advocates are implicitly assuming we are to the right of the peak.

So, what does the evidence say?

The good news is that it is possible to test this.  The bad news is that it is very hard to do it well.  One cannot simply assert that “in country X, they have tighter gun control laws and also fewer gun deaths, so therefore fewer guns causes fewer deaths.”  To do so would be to ignore countless other factors – cultural, religious, legal, economic, demographic – that might cause country X to have fewer deaths and also cause them to pass more stringent gun control laws.

Fortunately, some economists have written good papers on gun control.  (Sadly, other economists have written bad papers on gun control, meaning that they are sloppy, confuse correlation with causation, and therefore should not be used to guide policy debates.)

University of Chicago economist John Lott is the most well-known researcher on the issue.  His findings are easily summarized by the name of his book “More guns, less crime.”  In other words, Lott believes we are way past the peak and that people would likely be safer if we had fewer restrictions on guns.  As is often the case when someone writes something so provocative, Lott’s research has come under attack.  A summary of the controversies and criticisms can be found here.

Aside from just attacking Lott’s work, others have tried to examine this issue on their own.  In my opinion, the single best study on this topic was conducted by Prof. Mark Duggan, a Harvard-trained Ph.D. in economics who is now a professor at the Wharton School at the University of Pennsylvania.  His paper, “More Guns, More Crime” was published in one of the most elite peer-reviewed economics journals in the world.  He finds that “changes in homicide and gun ownership are significantly positively related” (thus, his title – more guns lead to more crime.)  Importantly, he also finds that “this relationship is almost entirely driven by the relationship between lagged changes in gun ownership and current changes in homicide.”  This is really important because it is evidence that this correlation comes about because guns lead to more homicides, rather than an increase in homicides leading more people to buy guns.

The Duggan study also specifically examines the Lott study.  He agrees that, theoretically, concealed carry laws could increase the likelihood that potential victims could carry a gun, and thus reduce the homicide rate (my simple model above).  However, he concludes that he finds “no evidence that counties with above-average rates of gun ownership within CCW states experienced larger declines in crime than low-ownership counties did, suggesting either that gun owners did not increase the frequency with which they carried their guns or that criminals were not being deterred.”  In other words, there is no evidence to support the NRA’s view.

I came into this debate over the past week with an open mind.  My reading of the evidence, however, suggests that more guns cause more crime, and that concealed carry laws would not reduce crime.

Our nation may still decide not to restrict guns because of the Second Amendment.  But if so, let’s at least do it with our eyes open.  We should not be pretending that we are helping kids by promoting gun ownership.

This past week, I reached Gold Status on American Airlines, which, along with some economics credentials, makes me qualified to give airlines some advice.

In my opinion, the most frustrating experiences of flying are the lines: bag check, security, boarding. I’m not going to debate security procedures here, but I will talk about the best way to reduce the boarding line: start charging passengers for carry-on baggage that doesn’t fit under their seat.

There’s nothing more frustrating than watching a long line of people try to stuff their clearly too-large roller suitcases into the overhead bins. Actually, there is: when it turns out that there isn’t enough space in the overhead bins and people have to start checking their carry-ons. The delay created by these phenomena costs the airlines a lot of money. A few years ago, a study calculated that padded schedules, which happen because airlines anticipate delays, cost them about $4.1 billion that year. Reducing the time that it takes people to board the plane could shave off some of that cost. Reducing the amount of stuff people bring on the plane would definitely reduce boarding time.

What would happen if airlines started charging for carry-on bags? Presumably, people would (a) pack fewer things and (b) check more bags. An alternative would be to stop charging for checked bags. However, that option would probably raise costs because people would pack more things into their suitcases and bring more suitcases with them. Fuel costs already make up around 40% of airlines’ costs, so adding more bags (and thus weight) to planes by not charging people what they cost to transport is not desirable.

Why don’t airlines charge for carry-on bags already? I’m guessing it’s some kind of game theoretic equilibrium where it’s good for everyone to charge for carry-ons, but bad to be the first mover. This is certainly consistent with what happened to free bags and meals: once someone started charging for checked bags and stopped serving meals, everyone else followed. Though Spirit already charges $20 per carry-on and will start charging $25 in November. Care to follow, anyone?

Beef Magazine is the last publication I expected to find an article to write about given that I have previously posted entries about plant-based substitutes for meat (here) and a United Nations report urging vegan diets (here).  However, a recent article published by Beef Magazine, which summaries the results of a survey on the “factors impacting public perceptions of animal welfare and animal rights,” caught my attention.  The article titled “Consumer Perceptions Will Determine Agricultural Practices” reports many findings from the survey, but I will focus on the three most interesting results.

• 91 percent of people agree that animals need to be treated humanely in order to qualify as “ethical food”.

This finding highlights the fact that food is not just calories and nutrients, but a meaningful and important part of people’s lives.  Food can invoke wonderful childhood memories.  Some people turn to comfort foods when having a bad day.  Food is often the center of social gatherings.  Given the prominent connection between emotions and food, it is comforting that the vast majority of people agree that humane practices are necessary for ethical food.

• 75 percent of people would vote for a law that would require farmers to treat animals more humanely.

Despite the generally pro-market leanings of Americans, clearly most people do not trust for-profit farmers and corporations to always deliver humane outcomes.  Intuitively, people understand that market forces often result in a race-to-the-bottom due to pricing pressure, and thus laws are necessary to enforce ethical standards.

• 81 percent of people believe animals and humans have the same ability to feel pain.

In contrast to this statistic, the Vegetarian Research Group’s annual survey found that only 5 percent of Americans are vegetarian and approximately half of those are vegan (source).  I suspect that most people understand that animals feel pain because of interactions with companion animals (i.e. cats and dogs).  Yet killing is inherently violent and killing is required for eating animals.  If animals can feel pain, then why do we as a society choose to kill them for food?

Furthermore, the pain of animal slaughter extends to humans too and is endured by those who work in the slaughterhouses.  According to Bureau of Labor Statistics data analyzed by the The Atlantic, “The rate of serious injuries in meat-packing (as measured in lost workdays) is…the highest: more than five times the national average in private industry.”  At a more granular level, Timothy Pachirat’s new book Every Twelve Seconds provides a first-hand account of working at an industrial slaughterhouse and explores “how, as a society, we facilitate violent labor and hide away that which is too repugnant to contemplate.”  The title of the book refers to the kill rate at the slaughterhouse, 2500 cattle per 8 hour shift or one animal killed every 12 seconds.

Consumers have the ultimate power of choice.  Through our purchases we can collectively determine how our food is made and demand that it be ethically sourced.  We can choose to live our ethics in the supermarket check-out line.

Earlier this month, despite desperate appeals to reverse his execution order, Lennox, a simple family dog from Belfast (UK) was killed (source).  The Belfast City Council (BCC) in Northern Ireland had condemned Lennox to death for the crime of resembling a pit bull.  The BCC’s justification was compliance with the “The Dangerous Dogs (Northern Ireland) Order 1991”, which defines any dog deemed to have pit bull “characteristics”, as inherently dangerous and bred for fighting.  The law requires the seizure and destruction of such dogs.

The Order is an example of breed-specific legislation (BSL) in effect across many jurisdictions around the world.  Pit bulls often are the target of BSLs, but other breeds are affected too, such as Rottweilers and German Shepherds (source).  Many major cities in America have BSL that outlaw pit bulls, including Denver and Miami (source).  The idea behind BSL is to reduce dog bites and subsequent death in humans from these “dangerous” breeds.

Do these BSLs work?  The answer is no.  A study by the U.S. Centers for Disease Control and Prevention (CDC) that reviewed a large sample of human dog bite-related fatalities over a 20-year period found, “Although fatal attacks on humans appear to be a breed-specific problem (pit bull-type dogs and Rottweilers), other breeds may bite and cause fatalities at higher rates.”  In other words, it is a common misperception that pit bulls are inherently more dangerous than other dogs.  Furthermore, analyses of specific BSLs find them to be ineffective, such is the case of the pit bull ban in Prince George’s County, MD (source).

In fact, all BSLs do is punish law-abiding citizens with harmless companion animals, as in the case of Lennox.  Criminals use pit bulls for fighting, but that is neither the fault of those dogs specifically, nor the breed in general.  Instead of BSLs, experts recommend breed-neutral legislation that focus on the deeds instead of breeds, as well as preventative measures such as mandatory spaying/neutering and compulsory leash laws  (source).  Poorly socialized, vicious dogs do exist and need to be taken seriously, but steps should be taken to protect the public in accordance with breed-neutral laws already on the books.

Finally, on a personal note, my partner and I have two beautiful pit bull mixes.  Lucy and Emmy are two wonderful and loving ladies.  Every once in a while, they steal food from the table, but then again what dog doesn’t?!

Way back on May 18, I wrote a blog called “Why YOU may LIKE Government ‘Theft’”.  In it, I listed four possible justifications for government to act like Robin Hood, taking from the rich to give to the poor.  This combination of economics and philosophy is meant to help each of us think about what really should be the top personal marginal tax rate: should it be higher or lower than currently?  This topic is hotly debated these days in the newspapers!

In that blog, I listed all four justifications, any one of which may or may not ring true to you.  If one or more justification is unconvincing, then perhaps a different justification is more appealing.  I put off the last three justifications to later blogs and mostly just discussed the first one, namely, that some “ethicists” in the field of “moral philosophy” have found ethical justifications for extra help to the poor.  The moral justification may be the most common or usual one; you might think it morally just or fair to help the poor starving masses.  That blog describes a range of philosophies, all the way from “no help to poor” (Nozick) in a spectrum that ends with “all emphasis on the poor” (Rawls).

But that’s not the only reason to have some degree of progressivity in our income tax system (taking higher percentages of income from those with more income).  The second justification basically says okay, let’s skip the moral theorizing.  Instead, suppose the poor are not deemed special at all.  Suppose that ALL individuals receive the exact same weight.  Suppose the objective is to maximize the un-weighted sum of all individuals’ wellbeing (or what we call “utility”).  Actually, this is perhaps the view of Jeremy Bentham, who came to be considered the “founding figure of modern utilitarianism.”  His philosophy is “the greatest happiness of the greatest number”.  That is, just add up all individual utilities, without weights, and maximize that sum.

So far, that might sound like no justification for taking from the rich to give to the poor.  However, we did not say just add up their incomes, or to maximize total GNP.   Instead, one might also believe that utility is not proportional to income, but is instead a curved function, as in the diagram below.  In other words, “declining marginal utility”.  If so, then a dollar from a rich person is relatively unimportant to that rich person, while a dollar to a poor person is very important to that poor person.  In that case, equal weights on everybody would still mean that total welfare could increase by taking from the rich in order to help the poor.

The only remaining question is the degree of curvature, or the rate at which marginal utility declines.  If it is a nearly straight line, then we might not want much redistribution.  But if it has a lot of curvature, then the sum of utilities could be maximized by taking more from the rich than we do currently.

So, what do you think?  I invite your comments.

In 2010, U.S. researchers conducted experiments on 1,134,693 animals – including 71,317 nonhuman primates – according to U.S. Department of Agriculture data collected in compliance with the Animal Welfare Act (source).  Almost 100,000 of those animals were subjected to experiments in which researchers intentionally inflicted pain and did not administer pain relief.  These data exclude experiments conducted on birds, mice, and rats because they do not fall under the definition of “animal” used in the AWA (source), and thus the real number of animals under experimentation in the U.S. could be in the tens of millions per year.

What, if anything, does society gain from these experiments on animals?  The statistics say not much.

Many argue that animal experimentation is most useful in pharmaceutical research and vital to new drug development.  However, a Food and Drug Administration (FDA) study found that “92 out of every 100 drugs that successfully pass animal trials and go into human clinical testing fail during the human clinical trial phase (source/source).”   That is a lot of animal suffering for less than a 10% success rate on humans.

Question: What about the drugs that do not pass the animal testing and thus “save” humans from harm?  Answer: With such a dismal record of prediction in one direction (success on animals to success on humans), what makes us confident of our predictive powers in the other direction (failure on animals to failure on humans)?  Of course, we do not have statistics on this counterfactual and thus will never know.  Indeed, it is possible that the miracle cure for cancer in humans failed trials with mice and thus was not tested on humans.

It seems clear that pharmaceutical companies and the FDA are reluctant to drop animal testing for one important reason: liability.  They want to be able to say ‘look, we tried it on animals’ if something goes wrong in the human testing phase.  However, even after all that testing on animal, and then on humans, the FDA still has to recall from market hundreds and sometimes thousands of drugs per year (source).  Stop experimenting on animals now, it only causes suffering for them and humans do not see much benefit – if any at all.

Environmental Policy Update:  Many contributors on this blog have written about climate change policy.  With the Supreme Court’s health care ruling yesterday, I thought this piece of news might fall under the radar.  On Tuesday, a federal appeals court rejected multiple challenges to new U.S. Environmental Protection Agency (EPA) rules that would reduce greenhouse gas emissions at large sources, such as power plants and large factories.  Michael Gerrard, director of the Center for Climate Change Law at Columbia University, said the decision was exceeded in importance only by the Supreme Court ruling five years ago that greenhouse gases could be controlled as air pollutants (source).

In a previous post, I examined a United Nations report urging reductions in the consumption of animal-based foods in order to mitigate climate change and avoid world hunger (here).  The report states, “Unlike fossil fuels, it is difficult to look for alternatives: people have to eat. A substantial reduction of impacts [from agriculture] would only be possible with a substantial worldwide diet change, away from animal products.”  Luckily, the concern with finding “alternatives” to eating animals now is no longer a major issue, thanks to a new, plant-based meat alternative developed here in the United States.

Beyond Meat is a Maryland based company that invented a plant-based chicken alternative called Veggie Chicken Strips.  In taste tests, “people either don’t notice the difference [from animal-based chicken], or love it and request it again (source).”  The Strips are relatively healthy with 19 grams of protein, 3 grams of fiber, 25% of recommended daily iron, and only 1.5 grams of non-saturated fat per 100 calorie serving (about 3 ounces).  The secret for this close-to-perfect substitute is a patented processing technique that combines soy and pea protein into the plant-based chicken.  Plans are in the works for beef and pork alternatives too.

The plant-based meat revolution has already begun in Europe.  The extraordinary growth of a Dutch company called The Vegetarian Butcher lead The Independent to ask “Is this the end of meat?”  Opened in 2010, The Vegetarian Butcher’s products now sell in 180 Netherlands outlets, with 500 more outlets coming this Summer and plans for international distribution soon.  Again, their vast array of plant-based meat fools the traditional animal eater.  In a taste test outside one of the Butcher’s shops, not one person guessed the smoke “mackerel” was not fish.

So the “alternative” to eating animals does exist.  The taste and texture of these plant-based meats are the same as the animal-based meats, but without the animal cruelty or environmental degradation.

Putting aside animal rights and the environment, the development of plant-based meat substitutes can help the average household as well.  Prices in the United States for animal-based meat will likely keep increasing as world-wide demand continues to rise (source), and Americans are already feeling the pinch as per capita animal consumption has fallen for 4 consecutive years, a trend expected to continue in 2012 (source). Meanwhile prices for these new, plant-based meats will fall as production increases and techniques are mastered.  These economic trends will lead to increases in plant-based meat consumption by non-vegetarians, but don’t worry, it’s a perfect substitute!

As I’ve said before, I’m not a lawyer.  But, since the Illinois House Democrats have decided to move into incentives, why not?  The details of the pension reform proposal that passed an Illinois House committee today are still vague, but here is a write up about it.

Simply put: the proposals currently under consideration in which members are offered a “choice” between options, as currently constructed, are not constitutional.  Here’s why.

The Illinois Constitution says that membership in a state pension program is a contractual relationship the benefits of which shall not be diminished or impaired.

Any contractual relationship has to have, well, a contract.  In this case, the terms of the contract are spelled out in the Illinois Pension Code.

The Illinois Pension Code specifies the way in which pension benefits will be calculated.  The details are slightly different for different pension funds, but I’ll talk about the part that pertains to Tier I participants in the State Universities Retirement System (SURS).  In particular, the amount of the retirement annuity is specified in Section 15-136 of the Pension Code.  Here it is:

Rule 1: The retirement annuity shall be … for persons who retire on or after January 1, 1998, 2.2% of the final rate of earnings for each year of service.

That seems pretty clear.  The “final rate of earnings” is defined in Section 15-112.  For a person who first becomes a participant before Jan. 1, 2011 (i.e., Tier I participants), the final rate of earnings is defined as:

For an employee who is paid on an hourly basis or who receives an annual salary in installments during 12 months of each academic year, the average annual earnings during the 48 consecutive calendar month period ending with the last day of final termination of employment or the 4 consecutive academic years of service in which the employee’s earnings were the highest, whichever is greater. For any other employee, the average annual earnings during the 4 consecutive academic years of service in which his or her earnings were the highest. For an employee with less than 48 months or 4 consecutive academic years of service, the average earnings during his or her entire period of service.

That also seems pretty clear.

One more excerpt from the Pension Code.  This one has to do with annual cost of living adjustments (COLAs).  From Section 15-136

The annuitant shall receive an increase in his or her monthly retirement annuity on each January 1 thereafter during the annuitant’s life of 3% of the monthly annuity provided under Rule 1, Rule 2, Rule 3, Rule 4, or Rule 5 contained in this Section. The change made under this subsection by P.A. 81-970 is effective January 1, 1980 and applies to each annuitant whose status as an employee terminates before or after that date.

Beginning January 1, 1990, all automatic annual increases payable under this Section shall be calculated as a percentage of the total annuity payable at the time of the increase, including all increases previously granted under this Article.

This part of the Pension Code also seems clear: COLAs are to “include all increases previously granted under this Article.”  In other words, COLAs compound rather than being based on the original amount of the annuity.  And, COLAs start the January after retirement.

So, let’s review.  The Illinois Constitution says that membership in a pension system is a contractual relationship. The terms of that contract are given by the Pension Code, and the Pension Code specifies the way in which final pension benefits should be computed.  In particular, it specifies that the final rate of earnings is average earnings over the final 4 years of service, or the 4 consecutive years in which earnings were the highest.  Thus, the Pension Code states that future pay raises will be included in future pension benefits.  The Pension Code also states that COLAs are to begin immediately after retirement and be computed on a compound basis.

So, let’s return to the “choice” that would be offered to members of the pension system under the proposal.  Details are sparse, but the basic choice to be offered to members will be:

(A)  Keep the current pension plan, but give up the state subsidy for retiree health benefits and having future raises be included in pension benefits, and

(B) Keep the state subsidy for retiree health benefits, but receive a less generous cost of living adjustment (COLA) where annual increases are based on the pension payment at the time of retirement rather than the most recent year’s pension.  That is, the COLA is not compounded over time.  Further, the COLA will not kick in until 5 years after retirement or age 67, whichever comes first.  There is also language in at least the governor’s proposal that will limit the COLA to a simple 3% or ½ the increase in the consumer price index, whichever is lower.

Now, supporters of this approach claim that is constitutional because it offers participants a choice.  This claim is invalid.  While a choice might be constitutional, in order for this to be the case, it must be that one of the options does not impair or diminish the benefits of the current pension system.  This is not true here.  Option (A) denies members their contractual right to have the final annual rate of earnings be based on their highest 4 years of earnings, which would include future raises.  Option (B) denies members their contractual right to have COLAs be 3% compounded each year.  Since both options impair and diminish the benefits of the pension, if members are forced to make a choice between A and B, their pension benefits will necessarily be reduced.

Constitutionally speaking, two wrongs don’t make a right.

Consequently, to me it seems clear that the proposals are not constitutional.  Given that so many of our legislators are backing these proposals, there must be an argument for why the proposal is constitutional.  I can’t see it, though.

ADDENDUM (5/30/12):  This isn’t a post about whether it is right or fair to reduce retiree health benefits (it isn’t), but rather whether it is constitutional (it probably is).  Retirees who began working for the State of Illinois before April 1986 (at least in the case of SURS) may not be eligible for Medicare Part A.  In this case, removing health insurance benefits would leave workers exposed to significant financial and health risk even after the age of 65.  The state also does not contribute to Social Security, so state workers who retire are also not eligible for Social Security (unless it is by virtue of having worked for another employer).  Obviously, removing employer-sponsored health benefits and reducing the COLA is going to expose retirees to substantial new risks, and the proposal becomes much more complicated and controversial in this case.

I’ve written over the past couple of weeks about public pensions in Illinois.  Short version: they’re a possibly-unfixable mess.  Since the state constitution forbids reducing promised benefits for current employees (or increasing contributions) and the state has failed to plan for their pension promises in a timely manner, the state is stuck between the proverbial rock and a hard place.

With this in mind, over the past few days I’ve been trying to think of unconventional ways in which the state can save money.  This is a bit tricky, since in the case of public employees the state pays their salary when they’re working AND their pension when they retire.  It’s the overall cost that matters.  So, for example, when the University of Illinois had an early retirement program last year, the University stopped paying them and SURS, the state university retirement system, started paying them.  But since both are ultimately using state dollars (but less-so in the case of the University, whose state appropriation as a fraction of overall cost has fallen drastically in recent years), this is really just a reshuffling of which pocket the money comes from.  The state is still on the hook.

Thinking outside the box leads to some crazy ideas.  And here’s one of them.  I make no promises about whether it will work in practice.  But it does point to some of the strange features of state finance.

Here’s the idea: to help the state’s pension system’s finances, the state should pay its workers more as they near retirement.  That’s right.  More.

As I started to play around with the idea, I had a dim recollection of reading something related.  It turns out that a couple of weeks ago, Andrew Biggs wrote in the Wall Street Journal about how cutting the Social Security payroll tax for workers nearing retirement could actually help the system’s finances.  The idea is simple: if older workers get to keep more of their wages, they’ll work longer.  And, if they’re working, they’re not collecting Social Security.  Lowering the payroll tax pushes back retirement, and this helps the system’s finances.  The idea is also related to my post from two weeks ago, where I discussed research showing that retiree health benefits induce early retirements.  If the state can’t pay retirees less and can’t ask them to contribute more, the only thing it can do to reduce pension costs is induce them to retire later, and it needs to do so in a way that costs less than the potential savings from delayed retirement.

So, how does it work?  Consider a worker near retirement age who has been working for the state his whole career, or at least long enough to reach the earnings cap on the state’s retirement system.  This worker, let’s call him Charlie, will earn 80% of his final salary after retirement.  And, assuming this worker was actually fulfilling a necessary function (e.g., teaching students finance), that worker will have to be replaced after retirement by a new worker.  Let’s call him David.  New workers tend to earn less than senior workers, so David will earn less than Charlie did.  Maybe David earns 80% of Charlie’s final salary.  But, essentially, after Charlie retires the state will be paying both Charlie and David – two people – to do work that could be supplied by one person.  While the state paid 100% of Charlie’s salary for that work before retirement, it pays 160% of Charlie’s salary after retirement!

So, the state has the potential to save a lot of money overall – 60% of Charlie’s salary per year – if it can induce Charlie to delay retirement.  Due to the non-impairment clause, a lot of the ordinary ways of doing this such as increasing the full retirement age are off the table.  One thing the state can do is increase Charlie’s salary.  This could be done through an actual wage increase or, as Biggs suggests, by reducing the 8% of wages that Charlie must pay into the retirement system as he nears retirement.

It is easy to see how it might be worth it to the state to spend more money on Charlie’s wages in order to delay his retirement.  But, let’s make up some simple numbers.  I’m going to ignore things like the fact that pension payments increase 3% per year and other details of the retirement system. They don’t change the basic insight, and the uncertainty involved with the other numbers that I’M JUST GOING TO MAKE UP is a much bigger deal than details like this.  I’m illustrating – not proposing policy.

So, suppose that increasing Charlie’s wage by 10% per year leads him to delay retirement by 3 years.  Suppose Charlie makes $50,000 per year and has maxed out his service so he’ll earn 80% of that ($40,000) after he retires.  Assume that David will earn $40,000 after he’s hired.

There are two things that should be taken into account.  If Charlie’s wage goes up, the basis for his pension will go up as well.  Roughly speaking, pensions are based on average earnings over the last four years of work.  Over these years, Charlie earns 50,000 for one year (the year before he gets the raise) and 55,000 for three years (after he gets the raise).  His final pension is 80% of the average, or 0.8 * 53,750 =  $43,000 per year.  Again, there are subtleties to the formula, but too many details obscure the main idea.  And, if Charlie works additional years, he will pay an additional 8% of salary into the pension system.  This would seem to be money that the state gets back.  But, as far as I can tell, these “excess contributions” are refunded to the employee at retirement.  So, in the case of a worker who has maxed out his pension, there would be no additional benefit to the state.  (For a worker who has not maxed out their pension, the state would receive additional contributions from the worker who delays retirement, but it would also have to pay an additional 2.2 percent of final earnings for each additional year of work, so it is unclear that this would benefit the state.)

Total 10 year cost if Charlie retires now:

Total 10 year cost if Charlie retires in 3 years:

So, the total savings over 10 years from my COMPLETELY MADE UP numbers is $54,000, or 6.75% of the cost under the current system.  And, this savings occurs in the first three years from not having to pay David.  Although I’ve ignored the time-value of money to keep things simple, the fact that the savings come up front would favor giving Charlie the raise if there were a positive interest rate.

Whether a scheme like this could actually save money would depend on a lot of things.  Among them are how much more near-retirees need to be paid to delay retirement, how long the delay retirement for, the relative cost of replacement workers, the length of time over which retirees draw pensions, and the time-value of money. Again, for the purposes of illustration, I COMPLETELY MADE UP THE NUMBERS ABOVE.  Economists invest a lot of time and energy in estimating quantities like these, though, and they’d need to do so before anything like this could go forward.

One crucial factor would be how well the state can target workers who are really on the margin of whether or not to retire.  While a wage increase across the board would be extremely unlikely to save the state money, one that is targeted at workers who are thinking about retiring and induces them to delay retirement just might.  One thing’s for sure: it wouldn’t run afoul of the non-impairment clause!

in•cred•i•ble (adjective): too extraordinary and improbable to be believed.

I wrote last week about the Illinois public pension mess and how ceasing to offer fully-paid retiree health benefits might help to address the problem by causing workers to delay retirement.  The reason why such a convoluted route to reducing pension costs is needed is because of the non-impairment clause of the Illinois state constitution, which prevents the state from reducing benefits for current employees.  In short, the non-impairment clause says that membership in a state pension system is a contractual relationship between the worker and the state.  And since contracts cannot be unilaterally renegotiated by one of the parties, the state is in a situation where it would seem to have no way out of its obligation to pay promised benefits to its current and future retirees.

In his proposal to reform the state pension system, Governor Quinn has tried to avoid the non-impairment clause by offering workers a choice.

On the one hand, current workers can keep their current pension plan but lose the right to have future pay increases be included in their final pension benefits and lose the subsidy that the state currently pays for retiree health benefits.  (Now, the first part of this plan clearly violates the non-impairment clause because the formula used to compute final benefits is specified in the Illinois Pension Code and clearly includes future pay raises.  But, that’s not today’s topic.)

On the other hand, employees can accept a significantly less-generous pension plan but maintain the employer subsidy toward retiree health benefits.  (Now, the less-generous pension plan pushes full retirement to age 67, when employees would be eligible for Medicare anyway, so it is unclear how valuable this promise would be to retirees.  But, that’s not today’s topic either.  There is also the real question of whether this would be considered “coercion” by the state.  In the past the Supreme Court of the United States has ruled that an employee cannot be coerced into giving up his pension benefits.  But, that’s also not today’s topic.)

This would be the time to ask ourselves why the non-impairment clause was included in the Illinois Constitution in the first place.  An analysis by Eric Madiar, Chief Legal Counsel to Illinois Senate President John Cullerton, confirms what you might suspect.  Public workers in the state of Illinois were concerned about whether the state would pay the pension benefits that it had promised them.  State and local workers generally receive lower cash wages than their private-sector counterparts, but higher benefits, including more generous pensions.  Thus, when an employee accepts a job working for state or local government, promised future pension benefits play a major role in making that job attractive enough for them to accept.  In light of this it is not surprising that they would be concerned about whether the state could be trusted to pay those future benefits.  This led state and local workers to propose that pension benefits be guaranteed in the Illinois constitution, and this proposal ultimately became the non-impairment clause.

Economists think a lot about commitment.  That is, we wonder about things like how it is that an agent can commit to take an action in the future that is not it its own short-term interest.  Or, we wonder how it is that an agent can be given incentives to take actions today that do not benefit it until the distant future.  Both of these issues arise in the context of pension funding.  In order to induce an worker to take a government job that pays less today, that worker must believe that the state will actually fulfill its promise to pay higher pension benefits in the future.  Similarly, in order for current legislators to cut current spending and use the money to fund future pension payments, there must be consequences.  The non-impairment clause addresses both of these issues.  The highest law of the state guarantees that the state will make the future payments.  This guarantee is so strong that a state that fails to properly plan for these payments will face fiscal collapse – as we do now.  Even in the face of fiscal collapse, the non-impairment clause suggests that pension payments must take precedent over many other payments.  With these promises in place, workers should be confident that the state will fulfill its future obligations.  Ideally, knowing that failure to plan for the future will jeopardize the entire state, legislators will make appropriate funding decisions to avert disaster.

Consequently, the non-impairment clause plays a vital role in the state’s finances.  Over the years it has been used to induce workers to accept a lower wage today in exchange for the seemingly-credible promise to provide higher benefits in the future.  In other words, the non-impairment clause has allowed the state to push the cost of paying current workers onto future taxpayers.  Kicking the can down the road in this manner has been a major tool in the state’s fiscal toolbox.

Let’s think about the role of commitment in regards to Governor Quinn’s proposed choice.  The plan says that those who want to keep their current pension will lose retiree health benefits.  The governor can take away retiree health benefits because they are not guaranteed by the non-impairment clause.  An employee who accepts the governor’s proposal would get a less-generous plan but keep the state’s promise of retiree health benefits.

In order for an employee to voluntarily accept this plan (if they believe that current pensions cannot be impaired), it must be because the employee values retiree health benefits.  But, even an employee who values retiree health benefits would have to believe that, when they retire in the future, the state would actually provide the promised benefits, and would continue to do so even if times were tough.  In fact, when times are tough that’s when people need their pensions the most.  So workers might be particularly concerned about whether a state under fiscal pressure would continue to fulfill their promises.  Sound familiar?

This is where things become a bit tricky for the state.  Times are tough right now, and the state has responded by threatening to take away retiree health benefits.  This has occurred both in the governor’s proposal and in the state legislature, where pending legislation would eliminate the state’s subsidy for retiree health premiums, which amounts to about $7400 per retiree per year.  So, the state is, on the one hand threatening to take away retiree health benefits and on the other hand asking workers to believe that their promise that those who accept the governor’s proposal will continue to receive these benefits in the future.  And, all of this is taking place in a situation that was brought about by the state’s failure to adequately plan to meet its constitutional obligation to pay pension benefits.

This brings us to the big question: Why should workers expect the state to honor its commitment to provide a non-guaranteed benefit when it isn’t even honoring the benefits that it is constitutionally obligated to provide? While the governor’s plan should be commended for attempting to address the pension crisis through asking workers to voluntarily accept a change in benefits, in the end I would be surprised if workers are willing to give up their constitutionally guaranteed pension benefits for an incredible promise to provide health benefits.

Practically speaking, any proposal that asks for voluntary acceptance by workers is going to have to exchange currently promised benefits for some promise of future benefits, and any such promise of future benefits is going to face this same credibility problem.  The state, by finding a way around its constitutional promise of future benefits, may find that it loses the ability to induce people to work today for lower wages and promises of higher payments via pensions in the future.  If workers respond to this by insisting on higher wages today, the state may find itself facing a choice between higher wage costs or lower-quality workers.  Even if the state can find a way around the non-impairment clause, it will not be without its costs.

ADDENDUM (5/30/12):  Retirees who began working for the State of Illinois before April 1986 (at least in the case of SURS) may not be eligible for Medicare Part A.  In this case, removing health insurance benefits would leave workers exposed to significant financial and health risk even after the age of 65.  Obviously, removing employer-sponsored health benefits is much more complicated and controversial in this case.