A Proposal That Would Make Pension Crisis Even Worse

Commentary

A Proposal That Would Make Pension Crisis Even Worse

It is the latest example of the unfunded public pension crisis hitting parts of California.

The California Public Employees’ Retirement System recently voted to cut benefits for nearly 200 retirees after the East San Gabriel Valley Human Services Consortium – which includes the cities of West Covina, Covina, Azusa and Glendora – failed to properly fund its pension plan for an agency known as LA Works.

It’s just the latest example of the unfunded public pension crisis hitting parts of California.

CalPERS, the largest public pension fund in the country, also recently lowered its target investment rate of return, tacitly acknowledging that the state has been too aggressive with its expectations on investment returns. As a result, local governments will have to increase their own contributions – both to make up for the previous use of an excessive assumed rate of return and in anticipation of lower returns in the future.

Continuing to provide the same pension plans “imposes greater costs on local and state government,” Gov. Jerry Brown recently told Bloomberg. “The pensions are squeezing local government more than state government.”

Brown also predicted CalPERS will have to lower its expected investment return rates even further, causing the financial pressure to “mount” on cash-strapped local governments.

Nonetheless, a new report by the well-regarded Haas Institute at the University of California at Berkeley claims the public pension crisis is exaggerated.

The Haas report claims public pensions are only considered in trouble because of unnecessary accounting standards about how to report degrees of risk. If only states like California were to adopt Social Security-style, pay-as-you-go approaches to funding benefits, the logic goes, then there would be no perception of crisis.

This proposal runs counter to how public pension plans are supposed to operate. The accounting rules governing pension systems like CalPERS require “prefunding” – setting aside a specific amount of money each year to be combined with investment returns so that on the day a worker retires, there is enough available to provide the promised retirement benefits.

Pre-funding pensions aims to avoid asking future taxpayers to cover the retirement costs for today’s workers, since future generations do not directly benefit from the public services delivered by current workers.

By contrast, shifting to a “PAYGO” model would enshrine an intergenerational equity problem. Politicians today would negotiate pay rates and benefits for today’s public sector employees, but lean on voiceless future employees and taxpayers to pay for most of the costs.

This kind of solution – reduce payments today and increase them tomorrow – is exactly the kind of thinking that got CalPERS and many other public pension plans into trouble in the first place.

There is nothing inherently wrong with providing retirement income via a defined-benefit pension plan. But, if state and local governments are going to provide pensions, they must properly prefund those benefits. The proliferation of unfunded pension liabilities has largely been caused by state and local pension boards failing to adequately predict the future, along with being too slow to increase contribution rates as necessary.

Unfortunately, when a pension plan’s investment assumptions about the future are wrong, it will come up short on the money necessary to pay benefits – with taxpayers on the hook for covering those shortfalls. CalPERS is slowly recognizing that its past assumptions have been too optimistic, which is a primary source of the pension debt driving up local government contribution rates.

When CalPERS announced it was reducing the pensions of the almost 200 former LA Works employees, its statement said, “The board was forced to make this painful decision after East San Gabriel Valley failed to stand by its contractual obligations despite repeated and numerous attempts by CalPERS to avoid this terrible situation.”

Abandoning the prefunding of pensions would ultimately result in many more “painful” and “terrible” situations that end with retirees not receiving the benefits they were promised.

Relying on future politicians to prioritize paying for pension benefits out of general fund revenue instead of using that money for public safety, education, or transportation projects is a recipe for a new kind of retirement disaster.

This column first appeared in the Orange County Register.

Leonard Gilroy is vice president of government reform at Reason Foundation, a nonprofit think tank advancing free minds and free markets. He also serves as senior managing director of the Pension Integrity Project at Reason Foundation, which assists policymakers and other stakeholders in designing, analyzing and implementing public sector pension reforms.

Anthony Randazzo

Anthony Randazzo is a senior fellow at Reason Foundation, a nonprofit think tank advancing free minds and free markets.