Public Employee Pensions and Benefits
Is your family ready to bend their budget to pay for Pennsylvania's pension crisis? State pension costs are set to drive up the average family's taxes by nearly $900 annually, but Senate Democrats claim to have a solution. This week they proposed borrowing $9 billion in pension obligation bonds to invest and drive down more than $47 billion in unfunded liabilities of the two state pension systems (PSERS for teachers and SERS for state workers).
Unfortunately, as the saying goes: If it sounds to good to be true, it probably is. Pension obligation bond's are a risky proposition. Issuing bonds without pension reforms, could put taxpayers on the hook for billions more.
Senator Pat Browne notes in Capitolwire [subscription required], "The history of pension obligations bonds is they represent a tremendous amount of risk. Across the country, when they have been used, there have been very mixed results."
For example, under then-Mayor Rendell, Philadelphia issued $1.29 billion in pension bonds to balance the budget. But underfunding continued and pension liabilities grew higher still.
The experience of Philadelphia shows that pension obligation bonds alone are not the answer to Pennsylvania's pension woes. And it's because they fail remove politics from pensions. To achieve that, any pension reform plan should include a defined contribution feature to avoid future crises.
In a defined contribution plan, funds are deposited into an employee's personal account, and it becomes impossible to increase benefits without paying for it. Underfunding requires telling workers that required deposits aren't being made into their accounts. Such a transparent plan prevents political manipulation and wouldn't take any benefits already earned away from retirees or current workers.
It's commendable to see Senate Democrats acknowledging the pension crisis, but their proposed solution is a risk taxpayers can't afford to take.
Pension reform promises to be on the forefront of the legislative agenda in the new year, and for good reason.
PSERS and SERS, the state’s two pension systems for public school and state employees, owe a combined $47 billion in unfunded liabilities. Not only have pension costs driven a downgrade on Pennsylvania’s bond rating, but they siphon taxes away from other budget priorities.
The consequences of doing nothing are significant: Within four years, state and school district pension contribution increases will cost taxpayers an additional $900 per household per year.
So, what's the solution to the pension crisis?
According to the American Legislative Exchange Council's "Keeping the Promise: State Solutions for Government Pension Reform," the political nature of the current defined-benefit (DB) plans creates a "fiscal time bomb" as legislators increase benefits without the ability to make annual payments. Former Utah State Senator Dan Liljenquist outlines several legislative options and recommends switching to a defined-contribution plan (DC) to make future obligations affordable, predictable, and sustainable.
But some charge that transitioning to a DC plan will cost the state more money. Luckily, Twenty Myths about Public-Sector Pension Plans, compiled by Richard C. Dreyfuss, a Senior Fellow at the Manhattan Institute and the Commonwealth Foundation, provides some much-needed clarity.
He writes that the estimated transition costs fall well below the costs of continuing a DB plan—where unreliable contributions, benefit increases, and unrealistic returns promise to magnify the current crisis. Michigan provides a case study for successful reform. Dreyfuss estimates taxpayer savings of $2.2 to $4.2 billion since switching to a DC plan in 1997.
Now is the time to enact trasformative pension reform, keeping in mind the lessons learned from other states. Doing nothing is simply not an option.
"They are going to take away your pension!" is a common scare tactic used by Pennsylvania government union leaders to oppose pension reform (even though private school unions have agreed to pension reform).
Such a scenario is no longer fiction for workers in Detroit. Yesterday a federal bankruptcy court ruled the City of Detroit has the ability to renegotiate pension benefits, like any other contract with the city’s 100,000 plus creditors. The dramatic development has widespread implications across the country—including Pennsylvania, where unfunded local and state pension liabilities surpass $50 billion.
Ironically, union officials' refusal to consider reform has endangered the very pensions they claimed they were protecting.
We've noted before the desperate municipal situations in Scranton, Pittsburgh, Allentown and Harrisburg. Government union leaders' unwillingness to compromise and ignore fiscal reality have put these cities on Detroit’s destructive path—harming taxpayers, residents and government employees.
Only by depoliticizing government pensions with 401(k)-type plans will state and local workers be able to keep their pension and create a system that’s fair to new workers and taxpayers.
Pennsylvania's fiscal outlook looks bleak according to a detailed report examining state revenue and spending released by the Independent Fiscal Office (IFO) last week.
The agency projects a general fund budget deficit every year for the next five years. In 2018-19, the IFO projects a budget deficit of almost $2.1 billion. To make matters worse, these projections assume an improvement in economic conditions, which would mean more tax revenue to help pay for state government’s ever-growing expenditures. But such an improvement is far from certain.
This budget shortfall is not a new problem, but one caused by years of overspending. State general fund spending has exceeded state revenue for six consecutive years. This overspending was made possible through federal stimulus funds, along with using the "Rainy Day Fund," and transferring more than $3 billion from other funds for one-time revenue.
The report hits on the two main causes of Pennsylvania’s structural fiscal problems: welfare spending and employee compensation. Recent news reports have brought renewed attention to the rampant waste and fraud in welfare spending. Lawmakers cannot begin addressing our fiscal cliff without taking steps to address abuses and enacting reforms to mend our safety net.
Further, increases in most areas of the state budget will be dwarfed by massive increases in state pension contributions. The report projects state pension contributions will increase from $1.4 billion to almost $3.4 billion, an increase of nearly 143%. This is why pension reform is critical.
Lawmakers must begin to rein in this out-of-control-spending, as these spending trends are unsustainable, and taxpayers—already burdened with the 10th highest state taxes—cannot be asked to simply pay more.
Thousands of school teachers in Philadelphia will see their retirement plans switched to 401(k)-type plans next year—and the union representing those teachers is okay with the reform.
I should have noted this is happening in Catholic schools.
The Archdiocese of Philadelphia is transitioning employees (including parochial school teachers and church employees) into a 401(k) plan going forward, which will match employee contributions with a 4.5 percent employer contribution. The reform will allow the Archdiocese to pay off its unfunded liability over 30 years (with no mention of the transition cost myth that has been used to undermine public pension reform).
The union representing some of the teachers affected thinks employees should be okay with the move, as Harold Brubaker at the Philadelphia Inquirer reports:
Rita C. Schwartz, president of the labor union that represents 650 teachers in archdiocesan high schools, said the move was not surprising, given the financial restructuring underway at the archdiocese in the last year.
"My concern is that our teachers don't panic," Schwartz said. "The pension's not gone. It's there."
Why did the private sector union take a different tact from the PSEA's misinformation campaign slogans like "Your pension is under attack" and "Keep the promise"?
Simply put, private unions recognize that employers need to have sustainable retirement plans or they may go out of business—costing union members their jobs. In government, the assumption is taxpayers can just keep paying more (though in reality, higher pension costs result in teacher layoffs too).
Lawmakers should take a lesson from the private sector in adopting meaningful pension reform.
Today, Rep. Glen Grell unveiled a state pension reform proposal.
We applaud Rep. Grell’s efforts to address the impending pension crisis. Absent reform, pension contributions will continue to soar, consuming more of our state budget while requiring property tax increases or teacher layoffs at the school district level.
We agree with Rep. Grell that we cannot afford to do nothing about the pension crisis. But we urge lawmakers to work for stronger reforms, most importantly, creating a 401(k) for new hires. We must find a solution that can pass both legislative chambers and preserve retirement for workers while protecting taxpayers.
There can be no doubt that Pennsylvania families and workers need lawmakers to take up pension reform now.
To learn more about pension reform, click here.
Traditional pensions are plagued by their dependence on guesswork—estimates on economic growth, employee behavior, and investment return—writes Grove City economist Mark Hendrickson in a recent piece. The errors in these costs are passed on to taxpayers, those same taxpayers who have seen private employers switch from traditional, defined-benefit plans to defined-contribution plans similar to a 401(k).
In sum, defined-benefit plans beguiled us. Attractive on the surface, they were inherently flawed due to the impossibility of knowing the future. Now it appears that they will cause a huge amount of strife and divisiveness in communities and states across the country in the coming years. There will be a lot of pain, and the political struggle will be over how that pain is distributed. It may take decades to sort out the mess, but ultimately, the only fair and viable (though still imperfect) system would be for everyone to have defined-contribution pension plans. Getting from here to there isn’t going to be easy.
Basically, traditional pensions can be easily manipulated for political gain. Thankfully, efforts to reform Pennsylvania's two pension system by putting new employees into a defined-contribution plan, like SB 922 and HB 1352 and HB 1353 have been making their way through the legislature.
Visit our activism page here to see how you can ensure lawmakers pass needed pension reform.
What do preschoolers with marshmallows and Pennsylvania’s pension crisis have in common? Both demonstrate a failure to delay gratification.
Dr. Joseph Horton at Grove City College compares Pennsylvania’s pension crisis to the classic psychological marshmallow experiment. In the experiment, preschoolers were given one marshmallow and promised two marshmallows if they waited 20 minutes (decades to a preschooler) before eating the first one. The children who were able to wait for the second marshmallow grew up to have more successful careers than the kids who ate right away.
According to Horton, Pennsylvania’s politicized pension system has fallen victim to immediate gratification:
It seems, in examples from all over the country, that we have elected too many politicians who would have chosen to immediately eat the single marshmallow. For example, Pennsylvania, where I live, currently has unfunded liabilities for state employee retirement benefits of approximately $47 billion, according to the Commonwealth Foundation. That means politicians have promised to pay $47 billion worth of benefits for which they have not set aside money. Our politicians have made promises without planning how to pay for them. We have been given the sugar rush today, but the bill will eventually come due.
So how do we instill the value of delayed gratification in state government? In today’s Patriot-News I suggest the solution is to take away politicians power to eat the marshmallow, or take the politics out of pensions. That means transitioning to a defined contribution, 401(k)-style plan where the costs are predictable because pension benefits must be paid as they are earned.
In fact, the primary reason we now have a $47 billion pension deficit is not because of the 2001 pension bump for teachers and state workers, or the 2002 increase for retirees Mr. Rowland lobbied for—though those combined added $10 billion to taxpayers’ debt—nor from underfunding.
Rather the majority of today’s pension liability was because actuary guesses were wrong. Our investments didn’t earn as much as they projected, and now taxpayers are on the hook for paying nearly $1,000 a year more per household for decades.”
It’s time to stop eating the marshmallows and refrain from consuming our children’s and grandchildren’s future success.
In July, a commentary by Matt Brouillette on why pension reform failed in our state legislature ran in several newspapers across Pennsylvania. Now response letters from teachers have been published in Erie, Allentown and Harrisburg that repeat myths on the "costs" of reforming our unaffordable pension system.
Here's the kicker, though: They're basically all the same letter, with slight stylistic differences. Ironic when educators are supposed to police against plagiarism. But then, each letter has been signed by current local or past union officers of the Pennsylvania State Education Association, a powerful foe of needed reform. Here's how each letter opens:
The Harrisburg Patriot-News: "The Commonwealth Foundation tries to promote itself as an advocate for fiscal conservatism. So it's strange that their president Matthew Brouillette actually promotes changes to public employee pensions which would increase costs to Pennsylvania’s taxpayers by at least $42.4 billion over the next 30 or so years."
The Morning-Call: "Although the Commonwealth Foundation promotes itself as an advocate for fiscal conservatism, its president, Matthew Brouillette, in a Your View actually promotes changes to public employee pensions that would increase costs to Pennsylvania taxpayers by at least $42.4 billion over the next 30 or so years."
The Erie Times: "The Commonwealth Foundation likes to promote itself as an advocate for fiscal conservatism. But its president, Matthew Brouillette, author of the Guest Voice 'Big Government Party dooms reforms' in the Erie Times-News on July 17, actually promotes changes to public employee pensions that would increase costs to Pennsylvania's taxpayers by at least $42.4 billion over the next 30 or so years."
More important than the copycat letters, however, is the claims they make. Will switching school teachers and other public employees to a 401(k)-style plan—what the vast majority of private sector businesses have done—actually cost taxpayers more than our current system? The answer is no, and it's plain to see why.
The estimates of costs are just that: Estimates. Actuaries don't agree on what the actual costs of a defined benefit plan are, because such plans are based on several assumptions.
For example, officials have assumed that our state plans for school employees and state workers will earn a 7.5 percent return, an estimate that has proven far too optimistic and added billions to our funding shortfall—a gap that taxpayers must now fill. It's also been assumed that our state legislature would continually and adequately fund the pension plans year to year, another assumption that's been proven wrong.
By contrast, defined contribution plans have completely predictable costs with no unfunded liability, because pension benefits must be funded as they're earned. Furthermore, if we "let Act 120 work," assuming both the unlikely 7.5 percent return and that lawmakers make payments on schedule, then taxpayers will pay $212.4 billion in pension costs over the next 30 years.
That's the real crisis facing taxpayers and teachers alike—not the supposed costs of fixing the system for our future.
On this BOX Program podcast, Representative Fred Keller (R) 85th District, joins Nathan Benefield to break down what's been happening in the legislature on pension reform. Both the House and Senate have considered bills this session that attempt to address Pennsylvania's failed public pension system by moving new hires to a defined contribution, 401(k)-like retirement plan.
It's a complicated issue, but its impact will reach Pennsylvania taxpayers for generations to come. Listen here.
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The Commonwealth Foundation is Pennsylvania's free-market think tank. The Commonwealth Foundation crafts free-market policies, convinces Pennsylvanians of their benefits, and counters attacks on liberty.