A Middle Ground in the Pension Wars

A Middle Ground in the Pension Wars

Pensions are in the news these days, as the retirement benefits of our nation’s hard-working public employees are being squeezed by economic realities and mismanagement by politicians. The most notable example of the danger posed by an underfunded pension system is Detroit, where in December a federal judge ruled that pension promises will not be protected during bankruptcy proceedings. Puerto Rico also has serious fiscal problems, and, despite attempts to reform its pension systems, the island’s debt was downgraded to junk status earlier this month by the major rating agencies.

These examples are extreme, but even more typical cases are unsettling given the roughly $2.7 trillion pension hole that states have to dig out of -- a hole that continues to deepen in many places. In the absence of new revenue sources, ballooning pension obligations are likely to crowd out other vital public services, such as education. For example, a recent analysis found that Milwaukee Public Schools face increasing pension costs that, without additional funding, could require the district to fire 24 percent of its teachers or cut their salaries and benefits by the same amount between now and 2020.

After years of failing to make adequate payments to public pension systems, politicians are finally starting to act. The resulting policies, such as reductions in benefits and shifts to the 401(k)-style plans common in the private sector, have been defended as necessary by reform proponents and attacked by public-sector employees and their unions as draconian and unfair.

There is an element of truth in both narratives. In our new report, "Improving Public Pensions: Balancing Competing Priorities," Patten Mahler, Russ Whitehurst, and I propose a middle ground in the pension wars.

It is clear that there is no one specific policy that will solve the problems of every state and local pension plan, as priorities and constraints vary widely, but any well-designed pension plan will strive to meet three goals: to provide an adequate and secure retirement for workers, to be financially sustainable, and to promote a highly effective public-sector workforce.

Existing defined-benefit pension systems promise benefits to employees but entrust politicians with the responsibility of setting aside adequate resources to pay for those benefits when they come due. These plans provide retirement security to some workers, such as those who work in one job for their entire career, but at the expense of many other workers; retirement wealth is significantly redistributed to career employees from more mobile employees -- even those who spend more than a decade serving the public.

This system creates incentives for workers to stay or quit that just don’t make any sense. An unhappy mid-career employee may feel compelled to stay in his current job to avoid losing future pension wealth rather than leaving and finding a more suitable position. On the other hand, a highly productive worker who has become eligible to receive his pension benefit may feel pushed to leave his post rather than forfeit that benefit. On top of it all, politicians have often made pension promises while leaving it to their successors -- and future taxpayers -- to foot the bill.

Further, while defined-benefit pension plans may have made sense in an earlier era, too often they fail to meet the goals of a well-designed retirement system today. A common proposal is to replace these plans with the kinds of defined-contribution plans that are common in the private sector, where employees have individual retirement accounts but no guaranteed yearly payment. These plans cannot be underfunded by definition, so employees are protected from the whims of politicians -- but the plans leave retirement accounts unprotected from market risk and are vehemently opposed by many public-sector workers and their unions.

Our proposal, a collective defined-contribution plan, combines many of the benefits of both defined-benefit and defined-contribution plans. In our plan, workers have individual, portable accounts that are professionally managed and spread risk across participants, so no one suffers from bad investment decisions or the poor condition of the economy at a particular point in time. The version of this plan we propose cannot be underfunded by short-sighted politicians, provides fair benefits to all employees (not just some, as current plans do), and protects employees from the market risks that plague retirement plans in the private sector.

The collective defined-contribution plan meets another important objective of pension reform: it is a policy with the potential to transcend traditional ideological boundaries. In the effort to address under-funded pension systems across the country, it is essential that policymakers of all political stripes find a middle ground that is fair to public employees, while saving all citizens from greater pain down the road. The collective defined-contribution retirement plan is one way to do just that.

Matthew M. Chingos is a fellow in the Brown Center on Education Policy at the Brookings Institution.  

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