As Illinois Democrats touted the $54 billion-plus FY 2006 budget they passed on Sunday, I could not help but recall my daughters’ delight at their first successful attempts to build a house out of playing cards.
The new budget is no less shaky, being built primarily on more than $2 billion worth of IOUs to the state’s public pension funds. Gov. Rod Blagojevich was one of the measure’s three Democrat architects.
The state has been short-changing its public employee pension system since the days of Gov. Jim Thompson, when long-term debt was structured so that the heaviest repayment burden falls on future taxpayers.
In 2003, for example, a $10 billion pension bond deal was reached. The repayments increase over time, from less than $500 million a year to more than $1 billion a year when the bonds are paid off in 2033.
Lawmakers in 2003 made sure taxpayers 30 years in the future would bear the heaviest burden for staving off the pension system’s collapse. The FY 2006 budget deal does the same thing.
Real reform measures that would stabilize the system, top to bottom, once and for all, have attracted little attention in a political environment better known for short-term promises than long-term solutions. Other state governments, and private employers across the country, have faced similar challenges far more successfully than has Illinois.
For example, most private-sector employers who offer retirement programs have moved from defined benefit programs (where retiree benefits are determined by a formula based on salary and years of service) to defined contribution programs (where the employer contributes a fixed amount per year to the employee’s privately held account).
The number of defined benefit pension plans dropped from 114,396 in 1985 to 31,238 in 2004, according to the federal Pension Benefit Guaranty Corporation, which insures the nation’s pension systems.
In the 1990s, the State of Michigan began putting new state employees into a defined contribution 401(k) plan. All new state employees hired after March 31, 1997 have been offered only the 401(k) option. Employees hired before that date may switch or stay in the defined benefit pension system.
In California, voters may soon get to vote on a constitutional amendment that would close the public employee pension program to new hires beginning July 1, 2007. New public employees would be offered a 401(k) program. Pension benefits to current employees and retirees would remain unchanged.
Defined contribution retirement plans have distinct advantages over defined benefit plans. Most importantly for Illinois’ public employees, defined contribution plans are owned by the employees themselves, so legislators could not “borrow”or steal from a worker’s retirement savings.
Defined contribution plans are portable: Vested employees who change jobs or become self-employed take their entire account with them. And with defined contribution plans, employees themselves control how much of their earnings to deposit in the plan, and they control how those contributions are invested. Most defined contribution plans allow employees to select a mix of stocks, bonds, and other investments with varying degrees of risk and reward.
California Assemblyman Keith Richman, who introduced the proposed constitutional amendment, explained, “defined benefit pension plans put taxpayers on the hook for any deficit that can’t be covered by investment gains. Public employees have very generous benefits, and taxpayers cannot afford to keep making these generous promises.”
Moving from defined benefits to defined contributions would strengthen Illinois’ pension system. That transition is commonplace in the private sector and among innovative state governments, and there is a wealth of expertise on how it can be done in a way that works for all stakeholders.
Budgets built on IOUs are nothing to be proud of. We can only hope state policymakers will use their summer recess to learn a new game.
Steve Stanek ([email protected]) is the author of Heartland Policy Study No. 107, “Illinois’ Public Pension Crisis,” released on May 24, 2005. He is also managing editor of a monthly publication addressing budget and tax policy issues across the country.