Getting Out of the Pension Dilemma

(Editors Note: This Commentary was originally published on March 8, 2006)

Pennsylvania’s public employee pension plans are facing a looming financial crisis. Regardless of how one looks at the current situation, our policymakers must confront a serious dilemma.

Taxpayer costs to fund the State Employees Retirement System (SERS) and the Public School Employees Retirement System (PSERS) are expected to increase in six years from about $1 Billion next year to close to $4.2 Billion in 2012 – and that’s only if the actuarial value of assets earns 8.5% annually. Returns that are more favorable, of course, would decrease future costs just as the reverse holds true.

So what can policymakers do to avert this coming financial crisis – other than hope for superior financial performance to continue into the foreseeable future?

The first step is to remind our state policymakers (those who designed these taxpayer-funded pension plans) to go back to the basics of Pension 101. There are only three ways to grow assets: 1) Increase employee contributions, 2) Increase taxpayer contributions, or 3) Increase investment earnings. Significant increases in any of these inputs could solve the looming pension crisis.

The first option lawmakers could consider is to increase employee contributions, as well as prohibit employees from withdrawing all of their accumulated contributions from the plans at retirement (which virtually everyone does). Employee contributions are reasonably significant, relative to the total pension plan assets, and every little bit would help.

However, according to PSERS Board Member and State Rep. Steve Nickol, the pension problem in Pennsylvania cannot be averted by raising employee contributions, or by reducing pension benefits, because courts have ruled both of those measures illegal.

The second option is to increase taxpayer contributions significantly. This tends to be the universal solution to many problems within government – and it is the likely solution to the coming crisis if nothing is done to avert it. In fact, even as property tax reform bills bounce around the Capitol, many lawmakers are working to ensure that pension costs are excluded from any taxpayer control. Doing so would allow unlimited property tax increases to pay for these pension liabilities.

Another related alternative is to start increasing the taxpayer contributions now so that the sticker shock of the taxpayer contribution amount in 2012 is muted. This seems to be the preferred approach of many in state government. In other words, start paying more now instead of waiting until later. Of course, this only spreads out the pain, it doesn’t relieve it.

The third option is to increase investment earnings. It’s simple: Harrisburg passes a law mandating the PSERS and SERS must earn at least 20 percent return on investment per year, every year. This, of course, is nonsense.

What, then, should state government do when all three options are unreasonable, impractical, or prohibited?

Gov. Rendell’s budget secretary, Michael Masch, proposed a fourth way; one that actually has some promise. He said he supports caps on employer (taxpayer) contributions that would prevent the state and school districts from paying exorbitant amounts toward pensions. This would keep the state’s pension promises to employees, but also start to protect the taxpayers from skyrocketing taxes.

Additionally, Masch said he would require taxpayers to continue contributing at constant rates even when PSERS and SERS’s assets performed well. Not necessarily a bad thing. But where would that leave us? Actually, it would do exactly what nearly every major corporation in America is starting do – move toward a “defined contribution” retirement plan where employer (taxpayer) costs are capped and predictable.

Unfortunately, this doesn’t solve the looming crisis, but it would certainly put Pennsylvania on the path toward good financial health. Now all Mr. Masch has to do is sell the solution to his boss.

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Richard C. Dreyfuss is a Senior Fellow with the Commonwealth Foundation (, a public policy research and educational institute located at the foot of the Capitol in Harrisburg. For more information on this topic, see Dreyfuss’s policy report Beneath the Surface: Pennsylvania’s Looming Pension & Healthcare Benefits Crisis.