Pinching Pensions

Dave Simpson began working for the state of Oregon right out of college. He knew that he'd make less than his friends who took jobs in the private sector, but for Dave, public service and a secure pension more than outweighed the lower pay. He spent his entire career with the state, working a variety of jobs, tackling everything from state parks to computer networks. Dave's story mirrors those of the vast majority of public employees: Serve your state, and earn a comfortable, but not lavish, retirement--according to the National Institute on Retirement Security, public-employee pensions average a modest $20,867 per year. Sometimes, their pension is all they have: Employees of all state governments were excluded from Social Security when it was created, and more than a quarter of them still aren't covered. Since Social Security benefits average less than $16,000 a year, the bonus for public employees is hardly lavish.

How is it, then, that these unassuming public servants, and particularly their pensions, are suddenly at the epicenter of a vitriolic conflict? At the conference of the Republican Governors Association last fall, Tim Pawlenty of Minnesota likened state employees to attempted murderers, declaring that "the public-employee unions would stick a shiv in all of us if they could." At the same conference, Scott Walker, then governor-elect of Wisconsin, took aim at state workers' benefits, declaring, "We cannot and should not maintain a system where public employees are the haves and the taxpayers footing the bill are the have-nots."

Public workers' pensions are likened daily in the news media to a crisis or a tsunami, about to drown us all. Even Democratic governors such as New York's Andrew Cuomo have proposed radically curtailing employees' retirement benefits.

Amid all the finger-pointing and rhetoric, the actual explanations behind the attacks on public employees and their pensions are easily obscured. Here's the real story: Public pensions are by and large well funded, and the recent shortfalls in the few states in trouble were nearly wholly caused by the stock-market crash. Ironically, a collapse caused by toxic financial products is now being used to punish working people a second time--in their role as pensioners.

Pensions are the largest tangible post-employment reward for a career that study after study shows pays less than comparable jobs in the private sector, even when those pension benefits are included. Most of the largely right-wing interest groups and politicians sounding the alarm over pensions hope that by attacking the benefits of public-sector employees, they will weaken public-sector unions and undermine confidence in state government, furthering both their political ambitions and small -- government ideology.

Let's unpack the critics' claims one by one. First, how bad off are state pension funds, really? Reports from both the Pew Center on the States and the Center for Economic and Policy Research (CEPR) agree that the total gap between the retirement benefits promised to current and former state employees and what the states currently have saved to pay for those benefits is about $650 billion, or about 20 percent of the states' total liabilities. Put another way, states as a group already have saved 80 percent of what they've currently promised to pay future retirees. Most of us would be ecstatic if we'd already saved 80 percent of what we need for retirement. But the legitimate concern is that any portion of the gap not closed by future returns would have to be filled by funds from state coffers.

Here's why that $650 billion gap isn't nearly as imposing as it seems. First off, the gap is partially illusory. Both the CEPR and Pew reports use the most recent data available. For most states, this is from the middle of 2009---practically the nadir of the most recent market downturn. According to a report from the National Association of State Retirement Administrators (NASRA), state pension assets have increased by nearly 25 percent since, wiping out around a quarter of the shortfall. In fact, according to the CEPR's report, nearly all of the gap can be, in a way, laid at the doorstep of the historically wretched returns of the past decade. They estimate that if investment returns of state pension funds had merely averaged what economists call the "risk free" rate of 4.5 percent a year since 2007, pension-fund assets would have been $857 billion higher than they are today and would more than plug the entire aggregate gap.

It's also important to emphasize that much of the gap is due to a few extremely underfunded states; in fact, just four states--California, Ohio, New Jersey, and Illinois--account for nearly 40 percent of it. According to both reports, most--around 30--states' funds were still adequately (more than 80 percent) funded during the depths of the economic crisis, and more have certainly since recovered along with the market. Finally, according to the same NASRA report, in 2010, more than 20 states either reduced benefits, increased state workers' contribution rates, or did both, helping close the gap even further.

In around a dozen states, however, the shortfalls are large enough that, even after the recovery partially refills funds' coffers, substantial reform will be necessary to keep the states' pensions solvent over the long term. Some of these states--most prominently, Illinois, New Jersey, and Ohio--have skipped or reduced required contributions, causing funding ratios to plummet. Others--including Kansas and Colorado--promised state workers higher benefits without also increasing the state's contribution, a favorite trick of politicians who want to give public employees "raises" but don't want the responsibility of paying for them. For these troubled states, making their pension funds whole would significantly dent their budgets; the Center on Budget and Policy Priorities estimates that New Jersey, for example, would have to contribute an additional 8 percent of its budget. But, despite media coverage to the contrary, these states are the exception rather than the rule, and several of them, including Illinois and Ohio, have already taken large steps to close their gaps.

If most state pension funds, then, were already healthy, made healthy by the market's recovery, or already being reformed, why have both the media and politicians created so much anxiety around this purported crisis? On the surface, much of the recent spate of public pension-bashing coverage in national news outlets, from The New York Times to Business Week, seems spurred primarily by superficial readings of reports like Pew's and the Census Bureau's "State and Local Government Public-Employee Retirement Systems Survey," highlighting these reports' large aggregate deficit numbers without providing context or detail. Yet upon closer examination, many of these media critics seem closely connected to interest groups likely to benefit, either financially or politically, from the demise of state pensions.

If public employees were forced into individual plans similar to those in the private sector, where workers' retirement prospects rise and fall with the whims of the financial markets, mutual funds (in which individual-plan assets are heavily invested), would stand to reap huge dividends from the shift. Many of the experts and think tanks frequently quoted in news stories about the pension "crisis" have ties to the financial industry. Joshua Rauh, a finance professor at Northwestern University quoted in both the Times and Business Week articles, along with nearly every other article on public pensions, is a former economist for Goldman Sachs and teaches for a school whose primary funders include such financial firms as CME Group, Grosvenor Capital Management, and JPMorgan Chase. Many of the think tanks quoted in the articles are industry-funded as well. For example, the board of trustees of the Manhattan Institute, ubiquitous in articles about New York state pensions, reads like a laundry list of prominent financial-investment and law firms. The usual crowd of prominent, consistently anti-government think tanks--Cato, the American Enterprise Institute, and the Heritage Foundation--are also frequently quoted as purportedly impartial experts.

Conservative state politicians have subsequently used this steady stream of negative coverage to propel pension-reform efforts under the guise of fiscal necessity, even in states whose pensions were completely solvent. Most prominently, Gov. Scott Walker has repeatedly blamed state employees' compensation--in particular, pension benefits--for the state's budget woes. But Wisconsin's pension fund is actually one of the best managed and funded in the nation. According to the same CEPR report, Wisconsin's pension fund had $79 billion in assets as of the end of 2009 and was 99.8 percent funded even while the state was still recovering from the crisis. In other words, the recession, not these already funded promises, was the real cause of Wisconsin's $1.7 billion deficit. Yet the budget bill that Walker prominently rammed through the Wisconsin Legislature amid massive protests not only stripped public employees of their bargaining rights (which saved the state nothing) but asked state employees to contribute nearly 10 percent of their salaries toward their already fully funded benefits--in effect a 10 percent pay cut--to plug the state's budget gap, conveniently reducing the power of the very unions that were Walker's biggest political opponents.

This isn't to say that all state pension-reform efforts are politically motivated. The pension systems of the previously mentioned dozen states, including two with newly elected Republican governors, New Jersey and Ohio, are facing serious shortfalls and are in real need of reform. But this debate is far too heavily influenced by commentators with conflicts of interest. And as pension-reform proposals gain steam in states across the spectrum of funding levels, it's vital in each case to distinguish rhetoric from reality.

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