The Manhattan Institute
State and municipal governments across the United States know that they are facing a looming financial crisis because of their pension obligations. Politically popular yet financially reckless decisions have left many of these governments with rapidly escalating pension costs. The situation is clearly unsustainable in the long term, which is why the issue of public-sector pensions is now front-page news from California to New York to Illinois (where legislators' wages recently were suspended for their perpetual failure to resolve that state's pension crisis).
These days, everyone knows that public-sector pension reform is essential. But what kind of reform? And how is it to be achieved? There is no shortage of debate (and a number of jurisdictions claim that they have put reforms in place). Much of this discussion, though, is marred by misinformation and half-truths. These misconceptions are confusing the public discussion about pensions and facilitating the enactment of pseudo-reforms that are politically attractive but financially inadequate.
This paper identifies these nuggets of misunderstanding and inaccuracy--the myths of public-sector pensions.
After outlining the requirements for real pension reform--how states and local governments can operate pension plans that do not threaten today's taxpayers with ever-increasing contribution levels or pass the costs of today's workers on to future generations--we describe the 20 myths that make such reform more difficult. Some are myths of fact (those commonly believed assertions about pensions and pension reform that are incorrect) and some are myths of analysis (interpretations and prescriptions that are seriously flawed). They range from misinterpretations of commonly used terms (such as "actuarially sound" and "cash-balance plan") to claims about the relative merits of defined benefit plans (exaggerated) and the risks of defined contribution plans (also exaggerated).
The goal of this paper is to facilitate a fact-based and analytically sound discussion of pension reform--a discussion that cannot succeed until these widespread myths are dispelled.
A key cause of the recent bankruptcy of the once-great city of Detroit was the overwhelming size of its pension obligations to its employees. Detroit is far from alone. Since 2008, a growing number of public pension plans have abandoned the standard of 100 percent funding (which rests on the bedrock assumption that benefits should be paid for as they are earned, rather than paid by future generations). As the consequences of this underfunding accumulate, more and more governments are facing considerable liquidity challenges, as higher employee pension contributions put pressure on their budgets. On current trends, the next phase of the crisis will bring more Detroits: governments will reach the end of their capacities to pay for pension contributions with financial manipulation and borrowing, and bankruptcies will be the result.
Thus pension finance has become headline news in many states. (In Illinois, for example, the governor suspended legislators' paychecks last summer, saying that they would not be paid until they successfully addressed the state's ongoing pension crisis.) It is now widely recognized that local and state governments urgently need to take steps to reform their pension systems.
But what steps? Too often, policymakers receive descriptions, analyses, proposals, and conclusions based on dubious assertions and interpretations of myriad laws, regulations, accounting requirements, and actuarial parlance. In this environment, financial manipulation and political image management can easily be branded and accepted as "pension reform." The situation is exacerbated by the incentives that politicians have to offer half-measures, where true reform would threaten their reelection chances.
The goal of any reform must be to ensure that pensions are properly funded in both the short and the long term. Yet changes toward those goals are frequently deferred, outright ignored, or predicated on overoptimistic forecasts of asset returns. States and cities must face the truth: they need to reform both the funding and the design of pensions (therefore addressing the question of whether and what benefits can be guaranteed). Only that kind of comprehensive reform will assure long-term sustainability.
Instead, many policy debates, and even so-called pension reforms continue to be based in half-truths, exaggerations, and erroneous but commonly accepted ideas.
This paper seeks to clarify a number of these assertions--we will call them the "myths of public-sector pension plans." Some of these accepted shibboleths of the pension debate are inaccurate; many others contain varying degrees of truth but often mislead because they aren't accompanied by necessary explanations.
Reasonable people will disagree about how best to balance the needs of public-sector retirees and taxpayers, overall--but all should be able to agree on the need for an informed debate based on accurate information and sound analysis. That is the goal of this paper, in which we present 20 myths about public-sector pensions. They are divided into myths of fact (those commonly believed assertions about pensions and pension reform that are incorrect) and myths of analysis (interpretations and prescriptions that are seriously flawed). Our goal is twofold: for those jurisdictions where public-sector pension reform is under discussion, we wish to improve the terms of the debate; and for those areas where "reforms" are in place, we want to help policymakers and the public distinguish between real reforms and pseudo-reforms that fail to address the underlying issues.
Continue reading this paper...
Richard C. Dreyfuss is a senior fellow at the Manhattan Institute's Center for State and Local Leadership and a regular contributor to PublicSectorInc.org. Dreyfuss is an actuary and business consultant. Refer to original article for related links and important documentation.
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