State governments must address the structural problems and incentives inherent in political management if government pension systems are to be returned to sound financial footing.
One central problem is that public officials have incentives to put off debts, such as retirement benefits, because the bills will not come due until they are long out of office. Fiscal restraint typically does not win elections. New government programs and goodies for the home district do.
Pension fund investment returns were so strong in the 1990s that governments didn’t need to pay much, if anything, to cover pension costs. During those flush years, many governments took “contribution holidays,” meaning they did not contribute at all to the pension system. Unfortunately, when the stock market inevitably corrected, governments discovered they had to make up for all the payments they didn’t make in years prior.
The sharp increase in tax revenues during the late 1990s also had impacts. Even after the stock market downturn had begun, most state governments could not resist the urge to spend the extra money they had recently accrued through higher tax revenues.
Public employee unions, which often play a major role in politicians’ election campaigns, wanted their piece of the pie, too. In California, the state and many municipal governments raised public safety workers’ pensions by 50 percent. Other government employees also saw significant benefit increases. This came at a time when workers in the private sector were seeing their benefits being scaled back.
— Adam B. Summers