Government Pensions and the Blame Game

 

Author’s Note: This post was originally written for The Wagner Review and can also be found at: http://www.thewagnerreview.org/2011/12/government-pensions-and-the-blame-game/

 

As the perennial punching bags of government budget fights, public sector workers need to take back the national narrative. Recently, government employees and their benefits have come under prominent attack in states like Wisconsin and Ohio. Unfortunately, the public rarely hears the real story—that the true culprits of underfunded pension liabilities are the legislatures and executives who spent these workers’ retirement funds on tax breaks and pet projects. It’s time to end these budgetary battles and stop vilifying public workers by passing laws to mandate fiscally honest pension contributions.

Year after year, politicians and the media spin the same yarn:  Once upon a time, public sector workers were paid fair wages and just benefits. Each year, workers demanded more money, and their unions attacked the election campaigns of fiscally-conservative politicians. Now, these lazy, greedy workers are living too long, retiring too early, and the public can’t afford it anymore—or so the story goes.

A cinematic parallel to this version of the pension story can found in the 1998 Cohen brothers cult classic film, The Big Lebowski. When the wealthy wife of Mr. Lebowski disappears, an opportunistic gang of German nihilists claim to have kidnapped her. When the protagonist refuses to pay the ransom, the nihilists famously and piteously query, “Where’s the money, Lebowski?” Blaming government workers for pension problems unduly casts them as equally selfish villains trying to squeeze the state for money that was never theirs to begin with.

In reality, today’s pension shortfall is the direct bill for decades of skipped payments. Each year, local and state governments with pension funds turn to their actuaries—loyal number-crunchers who analyze a workforce and predict, on average, how long its pension recipients will live. By examining the size and demographics of its beneficiary pool, actuaries can estimate with surprising accuracy the total annual payments that a government will be on the hook for in future years. If governments knew what their annual payouts would be, why didn’t they set aside enough money to pay them?

Governments learned long ago that buying stocks with their pension savings earns better returns than putting the money into interest-bearing accounts or buying bonds. This concept is a familiar one to private sector employees, who can follow the investment gains of their pension savings by watching their 401(k) accounts grow with the market. But in the public sector, employees typically have defined benefit plans that will pay fixed monthly amounts.  So, if governments have been making money on the stocks that they bought with employee pension funds, the Lebowski question emerges again: where are the extra investment earnings?

Pension funds don’t have extra earnings because governments adjust their contribution amount by the amount that they expect to earn through investing. By calculating how quickly a pension fund’s investments will grow, governments then calculate the direct contribution that, with the added investment gains, will provide them with the necessary pension savings to be able to cover their future employee pension liabilities. If all of the above is true, you might still wonder why states don’t have the money. The answer to this question is where the logic underlying government pension funds falls apart.

More often than not, government executives assume artificially high investment returns to reduce the amount of money they need to set aside for future workers’ pensions. After all, whether or not they bet too aggressively won’t matter for thirty years, and by then, it’s someone else’s problem. According to the Pew Center on the States, most states bake in a whopping eight percent annual investment return assumption. Citizens of these states would be wise to demand legislation mandating that their governments use conservative, independently-produced investment return assumptions. If states are to avoid further underfunding their pensions, it’s time to take politics out of the numbers.

It’s not just manipulating the numbers – in some cases, it’s ignoring them. When times are tough, some cities and states succumb to the temptation of underfunding their pension contributions to balance the budget. They do so knowing full well that they are saddling future taxpayers with the bill because it’s more politically palatable than raising taxes or cutting programs while in office.  In fact, the Pew Center estimates that thirty-one states have pension funds that are underfunded by at least twenty percent. Incredibly, New York was the only state in the entire union with a fully-funded pension fund, boasting a mere one percent surplus. All in all, based on states’ own actuarial assumptions, state pension funds are underfunded by a towering $1.26 trillion.

Ultimately, the actuarial calculations underlying pension funds may be complex, but the solutions to fund pensions needn’t be. First, governments must mandate independent and empirically-validated methods of estimating pension liabilities and investment returns.  Second, citizens must advocate for laws to prevent their governments from underfunding their annual pension payments. Such laws will force governments to keep their promises while ensuring that those promises are affordable.

Today’s taxpayers are already victims of past pension abuses—their children needn’t be.