Adding to the pressure created by rising Medicaid and other costs, local governments and school districts all over New York are being hammered by massive increases in pension costs for public employees.

This problem has two immediate causes: (1) the 2000-2002 Wall Street slump, which reduced the value of stocks owned by the retirement system, and (2) big increases in New York’s already generous pension benefits, which were approved by Gov. George Pataki and the Legislature just before the last stock market “bubble” began to burst four and a half years ago.

But the ultimate culprit here is New York’s outmoded and inherently volatile public pension structure, which obscures costs and wreaks havoc on long-term budget planning.

In the short term, there is nothing that government officials can do to reverse the recent run-up in pension costs, because the state constitution forbids any change in benefits for current employees. But, in the long term, New York’s public employee retirement plans can be made more predictable and affordable.

The answer – as Gov. Arnold Schwarzenegger recently proposed in California – lies in switching from government’s expensive and outdated pension guarantee to the sort of individual, savings-based approach that dominates the private-sector.

New York government workers currently are entitled to a guaranteed “defined benefit” pension based on career longevity and highest average pay. These payments are financed out of common pension trust funds, invested mainly in stocks and bonds, and replenished mainly by employer contributions.

The alternative approach – known as a “defined contribution” plan – consists of individual accounts supported by employer contributions, usually matched at least in part by the employees’ own pre-tax savings.

The vast majority of private-sector workers depend on 401(k)-style accounts for their retirements. But the concept is hardly new to government. After all, for decades now, a defined-contribution plan has been the retirement vehicle of choice for employees of public higher education systems such as the State University of New York.

To initiate such reform statewide, existing government employees would stay in the old system, but the overall expenses would drop quickly over the next 10 years due to natural turnover as replacement employees join the new retirement system.

For the first time, the cost of employee retirement benefits would be absolutely predictable in local government and school district budgets. It no longer would be possible for state officials to cut deals with unions to sweeten pension benefits while hiding the true expense in complex, off-budget pension funds.

A 401(k)-style plan would offer significant new advantages to workers as well. Benefits for public employees would finally be portable from job to job, between different levels of governments and across different jurisdictions, from public to private sector or vice versa.

By acting now to change the pension structure in a way that protects the interests of both employers and employees, state officials can make real progress in bringing these costs permanently under control.

About the Author

E.J. McMahon

Edmund J. McMahon is a senior fellow at the Empire Center.

Read more by E.J. McMahon

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