The MYTH of a Pension-driven Fiscal Crisis in the Public Sector

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“The evidence does not support the claim that states and localities are on the verge of bankruptcy because of massive unfunded pension liabilities.”

So says the Center on Budget and Policy Priorities in a January 20 report titled “Misunderstandings Regarding State Debt, Pensions, and Retiree Health Costs Create Unnecessary Alarm.”

We often hear the cry that the cost of public-sector pensions that have been put in place by state legislatures, city councils, county supervisors and other elected officials are financially unsustainable. Some openly advocate formal government bankruptcy filings as the way to escape the financial burden of public sector pension plans. But, is the cost of these pension plans really so onerous as to justify actions such as bankruptcy in an effort to cancel the government pension commitments that have been made?

No, says the Center on Budget and Policy Priorities.

While its January 20 report points out that some states, such as California, face a larger unfunded pension liability than others, it discusses various aspects of pension finance and comes to the conclusion that states, counties, cities and other governments should be able to manage their pension obligations. It also argues that the often cited nationwide public pension obligation deficit of $3 trillion is an exaggeration of reality, and questions any approach other than each government entity simply managing the issue.

It reports that some of the techniques that could be employed include increasing the annual government contribution to their pension plan to an average of 5% of payroll (the report notes that California, having failed to fully fund its pension obligations, might have to go to 7% of payroll). Of interest is the fact that some government entities that do not participate in Social Security, such as the County of Orange, are escaping the 6.2% employer tax that must be paid on employee earnings up to $ 106,800 per year. So, for the estimated 17,000 County of Orange employees, assuming an average employee pay of $ 60,000 a year, the county is escaping an annual Social Security employer contribution of $ 3,720 per employee, equal to $ 63.2 million a year. Given this fact the County of Orange is in a much better retiree cost position than are the counties and cities that provide not only a defined benefit retirement plan but also participate in Social Security.

Other techniques that could be applied to managing an unfunded pension liability include changing the pension plan by such things as increasing the minimum retirement age and/or length of service, changing how the earnings is determined upon which the retirement benefit is calculated (such as the average of the last 3 years worked vs. the average of the last single year) and/or increasing the employee contribution rate. Then there is the increasingly popular idea of tightening rules to eliminate or reduce such things as earnings and pension spiking and other techniques to boost pensions in the final years of employment. Skipping a few years of employee raises helps too, as the unfunded retirement liability estimate usually assumes that raises will be granted every year. These changes require tough collective bargaining, but if the political will is there coupled with the fiscal reality making these changes necessary, they could be achieved over time.

Noteworthy statements in the Center on Budget and Policy Priorities report include:

• It is mistaken to portray the current pension fund shortfall as an unfunded liability so massive that it will lead to bankruptcy or such other consequences.
• States and localities have the next 30 years in which to remedy any pension shortfalls.
• It would be unwise to encourage states to abrogate their responsibilities by enacting a bankruptcy statute. States have adequate means and tools to meet their obligations.
• Various pundits (and politicians) have suggested enacting federal legislation that would allow states to declare bankruptcy, potentially enabling them to default on their bonds, pay their vendors less than they are owed, and abrogate most union contracts. Such a provision could do considerable damage, and the necessity for it has not been proven.
• Barclays Capital in December, 2010 states: “Despite frequent media speculation to the contrary, we do not expect the level of defaults in the U.S. public finance market to spiral higher or even approach those in the private sector.”

This report seems to focus on what is so often true when faced with what appears to be a big problem – if you stop, think and analyze you will find that there are ways to manage it, to handle it, and that is a better approach for everyone rather than trying to just walk away from it. Even when tough collective bargaining is required that might lead to impasse followed by unilateral implementation if necessary. So, it seems that our electeds have the power of pension reform at their disposal – it is called managing the issue.


About Over But Not Out

A retired Orange County employee, and moderate Republican. The editor seriously does not know OBNO's identity as did not the former editor, but his point of view is obviously interesting and valued.