Defusing the Pension Bomb

by E.J. McMahon |  | City Journal

New York’s public-pension system has become the epicenter of an influence-peddling scandal that has attracted the attention of the Securities and Exchange Commission and the state’s attorney general. But the millions in shady “placement fees” pocketed by a few politically connected middlemen are small change compared with the mushrooming cost of lavish pension benefits for state and local government retirees. Keeping these retirees in clover will demand billions more from New York’s sorely stressed taxpayers over the next few years. And the real scandal is that politicians are so reluctant to do anything about it.

In New York, as in almost every state, public employees are entitled to defined-benefit (DB) pensions—a guaranteed post-retirement income, based on peak salaries and career longevity. By private-sector standards, benefit levels are extraordinary. New York state and local government employees, as well as employees of public authorities, can retire earlier, with larger pensions, than the vast majority of the people who pay their salaries. A New York teacher with 30 years on the job, for example, can stop working at 55 and start collecting an annual pension of roughly $55,000—entering retirement with the equivalent of a $1.2 million golden parachute, according to calculations by City Journalcontributing editor Nicole Gelinas.

Taxpayers must shoulder the risks of covering these already-promised benefits. The pensions are paid out of gigantic pooled retirement funds, to which government employers contribute varying amounts, depending on actuarial assumptions and market fluctuations. During the Wall Street boom of the 1990s, pension-fund assets grew enough to reduce employer contributions to all-time lows as a percentage of salaries. The downturn of 2001–03 had the opposite effect, rapidly driving pension contributions up. Since 2000, the combined annual pension costs for all governments in New York, including New York City, have risen from slightly under $1 billion to nearly $10 billion—reflecting both market conditions and benefit increases effective at the beginning of that period.

New York City’s annual pension contributions alone, up more than $3 billion over the last five years, are projected to rise by another $1 billion over the next three. Annual pension bills for the state and its local subdivisions, which now total about $3 billion, could double or triple by 2015. Rising pension costs also pose a considerable financial threat to the already-troubled Metropolitan Transportation Authority.

And these official numbers actually understate the problem because New York’s pension funds, like their counterparts throughout the country, calculate employer contributions based on government accounting standards that lowball their long-term liabilities. According to these skewed standards, the pension funds for New York State and New York City are technically at or near “fully funded” status. But Gotham’s actuary calculated in 2006 that New York City’s plans alone would be $45 billion in the hole if they employed the more sensible liability calculations that private-sector DB plans use.

Under the state’s constitution, pension benefits can’t be “diminished or impaired” for any current member of a public-retirement system in New York. So it will be difficult to stem the tide of mounting pension costs in the short term. The debate over pension reform is really about the appropriate mix of compensation for the next generation of government workers—and the impact they will have on state and local finances in the long term.

Far-fetched as it may seem, given the New York State Legislature’s shameless pandering to unions in recent years, there is precedent for pension reform. During the fiscal crisis of the 1970s, the legislature managed temporarily to scale back pension benefits for new public employees. However, the unions spent most of the next 25 years successfully clawing back much of what they had lost—and then some.

Porcine Pensions.

Governor David Paterson’s “Tier V” retirement plan, part of a June 5 deal with state employee unions, merely reset pension benefits to the levels of the early 1990s by raising the retirement age to 62; restoring a ten-year pension vesting period; and requiring employees to contribute to the pension fund throughout their careers. The governor also vetoed an extension of the existing “Tier II” retirement plan for police and firefighters, who can retire at half pay after 20 years, regardless of age. In its place, he proposed a plan that would set a minimum age of 50 for half-pay retirement after 25 years, which could produce significant savings for all New York municipalities, especially New York City.

Real pension reform, however, would go much further—by essentially throwing out the outmoded DB model for future employees. New York should follow the lead of a handful of other states, including Michigan, that have shifted non-uniformed government workers to defined-contribution (DC) accounts, like the 401(k) plans that have come to dominate the private sector. Paterson has estimated that his proposal would save the state and local governments outside New York City a total of $32 billion over the next 30 years. By comparison, a DC plan like Michigan’s, with the annual employer contribution capped at 7 percent of payroll, might save at least $10 billion more. But the greatest benefit of a DC system is that taxpayers would no longer bear all the financial risks associated with providing guaranteed pension benefits. For the first time, public-pension costs would become both predictable and easily understandable, and the real costs of proposed benefit increases would be completely transparent. With normal turnover, between one-quarter and one-third of state and city employees would be in the new system within a decade.

Of course, if pension reform were subject to regular contract negotiations, public-employee unions would never accept a shift to a DC plan from the guaranteed, ultra-secure DB plan. But this is a rare case in which elected officials can alter a fringe benefit without the unions’ consent—because the state’s Taylor Law, which governs public-sector labor issues, specifically prohibits collective bargaining on pensions. Retirement benefits could be changed legislatively, ensuring that future generations of New Yorkers aren’t stuck with the same pension problem.

Unfortunately, as the legislature’s 2009 regular session wound toward its June adjournment, leading politicians continued to seek union permission to make any changes. New York City mayor Michael Bloomberg has repeatedly called for the state to revert to a system in which pension benefits are collectively bargained, and Paterson made a series of costly concessions to the unions in exchange for their agreement not to oppose his modest restructuring of pension benefits. It’s time for the governor, the mayor, and other elected officials to reassert their managerial prerogatives—to understand that government unions will never voluntarily relinquish the gold-standard pensions that taxpayers can no longer afford.