While underperforming investments receive the most attention, they aren’t the real reason for the tax hikes and cuts in government services needed to bail out public pensions. In reality, the culprit is the extraordinarily generous nature of the benefits themselves, whose costs are only now coming to the surface.
Take my home state of Nevada, for example. Like most U.S. plans, the Public Employees’ Retirement System of Nevada (NVPERS) outperformed its investment target over the past 30 years, yet costs soared anyway — totaling 12 percent of all state and local tax revenue in 2013, the second highest rate nationwide.
A pair of studies by the American Enterprise Institute’s Andrew Biggs reveals why. The average benefit for full-career state workers is $1.325 million, at least 55 percent greater than that of their private-sector counterparts.
Those figures exclude NVPERS top-earners — police and fire officers — whose benefits are so rich and available at such a young age that it’s not uncommon to see retirees collecting six-figure pensions while still working full-time elsewhere. Former Las Vegas police officer Dan Coe tops that list: his starting $110,804 pension at age 38 is projected to total $13,216,000 in combined lifetime payouts.
Nevada isn’t the only place where this is happening. California’s multiple independent pension plans allow government workers to double dip without even leaving the state.
Marin County counsel Steven Woodside, for example, added two government pensions on top of his $258,000 salary last year: a $82,606 payout from his 12 years with Sonoma County plus a $97,206 allowance from his 29 years at Santa Clara County, according to the Transparent California website.
Unfortunately, the cost to sustain such generosity has grown so dramatically that even those who benefit from the system consider it “outrageous.”
Just across the bay from Woodside sits the Rodeo-Hercules fire district, where, in 2013, chief Charles Hanley cleared roughly $540,000 in total pay and benefits from California governments — $395,000 for his services as chief plus a pension of nearly $145,000 from the City of Santa Rosa.
When CBS San Francisco asked Hanley why the chief of such a tiny fire department — the district serves roughly 33,000 people over 25 square miles — costs so much, he was refreshingly candid. “People should be upset,” he responded, “and they should ask questions” regarding his “way too expensive” retirement costs.
To be clear, these employees did nothing wrong. They merely took advantage of the system offered to them, as anyone would. But as Hanley suggests, taxpayers should be asking questions. In particular, why are government retirement systems paying out six-figure pensions to those still in the prime of their working career?
Harvard economist Edward Glaeser considers public pensions a “shrouded cost of government” because of their inherent complexity. This shroud enabled Nevada’s public unions to lobby successfully for numerous pension enhancements, with legislators either not knowing (or caring) about their long-term costs.
Ultimately, a recurrent pattern emerged. Rather than using excess investment returns to pay down NVPERS billion-dollar deficit — as fiduciary guidelines dictate — lawmakers used them to pay for the additional enhancements.
This scheme extends far beyond Nevada. The most infamous example is the California Public Employees’ Retirement System, where the system’s $139 billion shortfall has been largely blamed on similarly irresponsible benefit enhancements in 1999 and 2001.
It’s easy to see why this legislative practice is so appealing: it allows lawmakers to get the best of both worlds. They can curry favor with government unions by enriching their benefits while keeping the costs of these increases invisible to most voters. And if costs skyrocket later on, that will be someone else’s problem.
This feature of defined benefit (DB) plans was highlighted as a fundamental “disadvantage” in a 2010 study commissioned by NVPERS and conducted by the Segal Group, an actuarial firm that receives millions of dollars from numerous U.S. public pension plans.
The failings of DB plans extend beyond their predisposition to financial mismanagement, however. They’re also an inefficient way for employers to compensate their employees.
If DB plans were superior in this regard — as is often claimed by their defenders — one would expect them to be embraced by private firms, which prize efficiency. But just the opposite has happened: the percentage of private workers enrolled exclusively in DB plans fell from 28 percent in 1979 to just 2 percent in 2013, according to the Employee Benefit Research Institute.
In fact, Cornell Professor Maria Fitzpatrick found that Illinois public school employees “value their pension benefits at about 19 cents on the dollar,” suggesting that governments are dramatically overpaying for their employees’ retirement benefits. Like Glaeser, Fitzpatrick attributes this inefficiency to the political nature of DB plans, which “drive[s] a wedge” between actual and perceived costs.
In other words, unions favor exorbitant pensions for government workers’ pensions because they see it as an easy way to covertly increase their compensation — not because they have some uniquely strong preference for a retirement-heavy pay package.
The DB model is failing government workers, too. By design, DB plans push costs onto future generations. Consequently, future workers will have more taken out of their paychecks to help pay for the benefits of those already retired, while at the same time often receiving less generous benefits themselves.
Finally, U.S. public pension plans’ flawed accounting methods and over-reliance on investment returns — rejected by private U.S. pension plans and both public and private plans in Canada and Europe — put retirees at risk. Should these practices lead to more defaults, as has already happened in Puerto Rico and several U.S. cities, retirees may face benefit cuts.
Transparency and equity are uncontroversial goals of government. The public should be able to ascertain the true costs of government programs, and those costs should be borne by those who benefit from them. Defined benefit plans fail spectacularly on both counts.
What’s the solution? Shifting to a defined contribution plan would provide superior transparency, cost stability, and reliability for both employees and employers. Lawmakers can learn from successful past reforms enacted by the federal government as well as more recent examples in Arizona and Utah.
Robert Fellner is the director of transparency research at the Nevada Policy Research Institute. This commentary was originally published on RealClearPolicy.com.