Unfunded government employee pensions are gobbling many states’ education budgets, leaving governments scrambling to find money to cover those in addition to school operating costs.
“Money doesn’t grow on trees, and it’s hard to raise taxes,” said Andrew Biggs, a pensions scholar at the American Enterprise Institute. “There’s less money around to pay for salaries and other benefits, less money for books, less money for buildings, less money for computers. [Taxpayers] are facing difficult choices.”
In Illinois, about 75 percent of education funding increases go to current teacher retirements, says Jonathan Ingram, pension and health policy director at the Illinois Policy Institute. Before long, most education funding will backfill teacher pensions, he said.
“If we don’t get this problem under control, we’re going to crowd out funding for education,” he said.
States are sitting on $4 trillion in unfunded pension liabilities, according to Biggs’ research. Since 2009, 45 states have trimmed less than a tenth of that. Since 2007, state and local governments have underpaid actuarially required pension contributions by more than $50 billion, according to U.S. Senator Jim DeMint’s (R-SC) office, which released a September state pensions report. DeMint argued “fiscally responsible states” should not have to “shoulder the bad decisions of irresponsible states.”
The huge shortfall is “something of a slow-burning problem,” Biggs said. Governments haven’t been funding their portion of state pensions all along, and now there is no money, he said.
Most government pensions are defined-benefit plans, meaning they offer workers a specific payout no matter what workers contribute.
The National Institute on Retirement Security studied pension systems and found many defined benefit plans that were successful—but the success hinged on the employer or state contributing to the plan, said Diane Oakley, executive director of NIRS.
“They’re cost-effective, and they’re sustainable … if the employer’s making a contribution and not just making a promise,” she said.
Tax-Paid ‘Ponzi Scheme’
Part of Illinois’ problem is that the government has used “very rosy estimates of their investments” to plan for the future, Ingram said. For the past five to 10 years, the state has expected roughly 8 percent returns while actually making approximately 4 percent, he said.
That’s true of most state pension plans. States have little incentive to estimate accurately, since an accurate accounting would compel them to dedicate more money to the plans. Government accounting rules are usually more lenient than private-sector accounting, Biggs said, and policymakers should begin by getting accurate numbers and facing up to the problem.
“Every time [a pension fund] goes under projections, taxpayers pick up the cost,” Ingram said. “Taxpayers should be worrying, and future teachers might not get a pension.”
Illinois’ Teacher Retirement System has consistently reported it doesn’t have enough money to pay retirees and depends on contributions from current teachers.
“When they run out of the assets, it truly becomes a Ponzi scheme,” Ingram said.
Government retirement benefits are typically much more generous than private benefits, Biggs said, and states can cut while keeping them competitive.
Ingram recommends states switch to defined-contribution plans for new hires, where the state contributes a specified amount to a worker’s retirement rather than ensuring a specific payout.
“We really give [employees] the power over their own retirement decisions, and we also give them the responsibility, too,” he said.
He also recommends freezing cost of living increases until pensions are fully funded, then matching increases to inflation.
Tweaks Not Enough
Lawmakers are beginning to realize the risks of defined-benefit pensions, Biggs said.
“Stock market returns are strong when the economy’s strong.… That means your system is going to become unfunded and require more money at exactly the time when the taxpayer is least likely to be able to give it,” he said.
Although some state lawmakers have taken small steps to address this problem, “none of them really addresses the core issue facing us, that pensions are just overly generous and the state doesn’t have the money to fund them,” Ingram said. “The longer lawmakers delay implementing those reforms, the harder it’s going to be.”
Many lawmakers don’t understand how big the problem is, he said, and they have a hard time saying no. Lawmakers often think “taxing and borrowing will solve the problem, when it’s really not a revenue problem; it’s a structural problem,” he said.
Individual vs. Taxpayer Risks
Defined contribution plans switch investment decisions to individuals, away from professional investors managing taxpayer-financed investments, Oakley notes. However, switching to a defined contribution plan doesn’t reduce any current unfunded liability, she said.
Defined-benefit plans also encourage employees to stay long term. Teachers typically take about five years to reach their peak, Oakley said, so schools often want to retain teachers after having trained them.
Biggs said defined-benefit pensions have “very strange incentives.” These plans hardly accumulate during a worker’s first several years on the job, slanting plans away from young employees.
Once an employee hits mid-career, benefits begin to ramp up quickly. In these years, employees are unlikely to leave voluntarily because they would give up huge pensions.
“These traditional plans are not very well structured in human resource terms, being able to attract people you want and get rid of the people you don’t want,” Biggs said. “A defined-contribution or a cash-balance plan works better.”
Image by IgorLazunna.