Far from being the setback some officials have claimed, the rejection of the $5.5 billion pension obligation bond was a blessing for West Virginia taxpayers. Attempting to borrow the state's way out of debt by issuing a bond would not have solved the state's pension troubles. In fact, it would have left in place the incentives and structures that allowed West Virginia to get into this pension mess in the first place and could have made things worse if the pension funds' investments earned less than the amount needed to pay interest on the bonds, as has happened in many other cities. Now, with bonds off the table, the state can focus on real pension reforms that truly will make a positive difference.
The first thing to do when you're in a hole, as Will Rogers once observed, is to stop digging. West Virginia's pension problem stems from decades of underfunding and mismanagement. Unfortunately, the bills racked up by previous politicians must be paid. West Virginia can lessen the blow to taxpayers, however, by adopting responsible fiscal management practices and implementing reforms to prevent the state from repeating its mistakes in the future.
First, the state should stop the bleeding by shifting to 401(k)-style defined-contribution retirement plans like those created to stop the funding freefall of the Teachers' Retirement System in 1991. Under a defined-contribution plan, the employer and employee each contribute a percentage of the employee's salary to a retirement account and the employee controls the investment of that account. Because they offer significantly better cost-certainty for employers and more freedom for employees than traditional retirement accounts, 401(k)-style plans are now the plan of choice in the private sector.
In 1992, nearly 60 percent of heads of households participated in traditional pension plans, and about the same number participated in defined-contribution plans (allowing for those with both types of plans). By 2001, almost 80 percent participated in defined-contribution plans and less than 40 percent participated in traditional pension plans. Defined-contribution plans offer more freedom to state employees because they allow them to invest their retirement assets as they please and "carry over" their accounts if they switch jobs or leave the government. They also provide more predictability to the government — and taxpayers — since contribution costs are always a certain percentage of employees' salaries, which do not change drastically from year to year.
But instead of curbing pension costs, Gov. Joe Manchin signed HB 2984 in May, closing the defined-contribution plan for the state's teachers and converting it back to the traditional, or defined-benefit plan that has achieved the dubious distinction as one of the worst-funded plans in the nation, with a shortfall of over $5 billion. Forgive taxpayers if they are not comforted by Gov. Manchin's mere promises that the government will be more responsible this time around.
In contrast to the fixed costs of 401(k) plans, defined-benefit plans guarantee taxpayers will pay a certain level of benefits based upon a percentage of the employee's final salary multiplied by the number of years of service — for life. As demonstrated by West Virginia's $5.5 billion unfunded pension liability, defined-benefit plans allow politicians to make pension promises the state can't afford. And when the pension fund's investment performance doesn't meet expectations, taxpayers are left on the hook for billions.
Shifting new state employees to 401(k) style plans would force the government to engage in responsible fiscal management by fully funding retirement accounts each year. There is no possibility of unfunded pension liabilities with a defined-contribution plan because the state does not have to guess about its future pension liabilities—they are simply the cost of its annual contributions to employees' retirement accounts. Government employees would be responsible for managing their own retirement and taxpayers would not be forced to pay for benefit promises the state cannot keep.
Defined-contribution plans are not the whole answer to the pension problem, however. Future benefits should be held in check through the enactment of a constitutional amendment requiring voter approval of any future pension benefit increases. Since politicians have proven to be irresponsible with taxpayers' money, taxpayers should have the power to act as a final check on excessive labor union influence and politicians' recklessness. This strategy has worked well in "liberal" San Francisco, while "conservative" cities like San Diego are drowning in pension debt and teetering on the verge of bankruptcy.
Individuals and households must live within their means, and governments should, too. Irresponsible government financial management has led to pension deficits that will burden not only current taxpayers, but future generations as well. Trying to borrow the state's way out of debt was never a good idea. Rather than throwing up his hands and pushing the problem onto the next governor, Gov. Manchin should now take this opportunity to enact real pension reform.
Adam B. Summers is a policy analyst at the Reason Foundation, a free-market think tank. He is co-author of a recent study examining pension troubles across the nation, including West Virginia's, titled "The Gathering Pension Storm: How Government Pension Plans are Breaking the Bank and Strategies for Reform."