It sounds like Governor Cuomo may be wavering on the optional defined-contribution (DC) retirement plan that was the single most innovative aspect of his Tier 6 pension reform proposal.

If he drops the DC option, it will be a big mistake–and an enormous lost opportunity.  But it won’t come as a complete surprise. Since Tier 6 was unveiled as part of the state budget last month, the Cuomo administration has made no serious effort to meaningfully engage its opponents in the debate over this aspect of the plan.

It certainly didn’t help that Cuomo’s proposal is seriously flawed to begin with, offering employees the option of a baseline DC plan consisting of a mandatory employer contribution of 4 percent of salary and a mandatory employee contribution of … zero.

A non-contributory option would be attractive to many young and low-wage employees, but a savings rate of 4 percent would not be nearly enough to provide a primary pension substitute, which unions pointed out. The governor said he wanted employees to have a choice of two types of plan, but then offered only a sketchy DC model.  For those willing to kick in 3 percent of their own salaries to a DC plan, the governor would increase the employer match to 7 percent, bringing the total to an only barely adequate 10 percent.

To make matters worse, he also has lapsed into the media’s usage of  “401(k)” as a synonym for his plan, which has played into the hands of his critics. While a 401(k) is the most common employer-sponsored DC plan in the private-sector, a state government DC option would have to be structured differently under federal tax law.  As explained in our in our “Optimal Option” report last week, the state’s established DC plan models, embraced by a total of 30,000 employees at the State University of New York (SUNY) and City University of New York (CUNY), are 401(a) plans built around lifetime annuities, which are not commonly featured in 401(k)s. We recommended that a SUNY-style plan for all general employees of state and local government should entail a combined employer-employee contribution of 12 percent of salary, with the employee share geared to match the levels proposed on the DB side of Cuomo’s Tier 6 bill.

In his budget presentation, Cuomo alluded to the SUNY plan as a model, but neither his legislation nor his budget briefing documents reflect this.  One clue to the amount of thoughtful consideration — or lack of it — that went into Cuomo’s defined-contribution plan is the way he discussed it in his radio interview yesterday with Fred Dicker, the New York Post bureau chief in the state Capitol.

“The DC, 401(k)-type option is a red herring in this discussion,” Cuomo said. “This is about savings … It’s not about 401(k), it’s about Tier 6, and it’s about reducing the benefits.”

Um, no. A DC option is primarily about

• portability and flexibility for employees who desire it; and
• financial transparency for taxpayers.

The savings such a plan may represent, compared to the traditional DB pension, is almost incidental to those first two objectives. It’s certainly no selling point to declare that a DC plan is “about reducing the benefits” — especially when, for many thousands of state and local workers who don’t vest in a traditional pension, a SUNY-style DC will increase benefits. Besides, the “cost” to employers of the more generous DC option recommended in our report would still be less than the “normal” rate of a Tier 5 pension plan. Even a flat-out duplication of the current and SUNY and CUNY plans, with their maximum 13 percent employer contributions for employees with at least 10 years of service, would cost New York City less than half as much as a traditional teacher pension, which requires an average employer contribution of more than 30 percent of salary.  It might also attract some skilled and experienced talent to the teaching pool.

Cuomo has cited the portability advantage of DC plans. However, he has never discussed the advantage of the DC option as a financial matter.  Municipal and school officials have made it clear they would prize the predictability offered by such a plan, but the governor doesn’t seem to have heard them on this point. Nor has the governor alluded, at all, to the structural problems of the DB system–which stem in large part from the permissive government accounting rules that allow public plans to discount future liabilities based on optimistic investment return assumptions, and the overhanging financial risk this creates for taxpayers.  Perhaps Cuomo would feel a bit self-conscious pointing out such things while his own budgets are pushing some of the state’s current pension expenses into the future.

If the DC option is withdrawn by the governor, Tier 6 is more likely to boil down to a sort of Tier 5a — a further iteration of the same basic pension system we’ve got, but with reduced benefits and increased contribution levels,  which unions will unravel as soon as economic and financial conditions take the pressure off.  Cuomo himself apparently expects it to happen. Consider this (truly incredible) exchange between the governor and Fred Dicker yesterday:

DICKER: By the way, I think you’ve made this point, there’s nothing that would prevent the state from having a Tier 7 down the road that strengthens benefits if the state can afford them and has a lot more money coming in as it used tomany  years ago before these big burdens were placed on the state.

CUOMO: And Fred, there’s no answer to that … because some people would say, look, maybe the economy’s going to improve and maybe if the economy improves we can afford higher benefits.  Your point is right — fine, then reduce the benefits now … and then if the economy gets better, increase it, when you can afford it.

Huh?  Increasing benefits when “the economy gets better”–the argument used to justify the 2000 pension sweeteners that taxpayers are now laboring to pay for–will greatly reduce any projected savings from Tier 6. So what’s the point here?

As for that DC option, perhaps the governor’s own proposal was, itself, a red herring all along.