Pension Reform Trap II

It’s been an item of faith among would-be pension reformers that switching public employees from defined benefit pension plans to defined contribution plans like 401(k)s would save taxpayers money. When I’ve suggested here that the savings may never materialize, the faithful have scoffed.

So here’s one, early data point: In its new budget, San Diego is projecting a $40 million increase in pension costs for the coming year, much of it due to the switch from defined benefit plans approved by voters in June 2012 in the Prop. B reform plan.

This is not a surprise. It was predicted by San Diego’s Independent Budget Analyst.

A switch to defined contribution pensions doesn’t, by itself, save money. Because of higher fees charged by financial institutions and the lower returns realized by individual workers in self-directed retirement accounts, it takes higher levels of contributions to achieve a given level of retirement savings in 401(k) plans. For the switch to save taxpayer dollars, government employers must either reduce their workers’ retirement saving or cut their wages. In San Diego, Prop B will yield lower costs for taxpayers only by holding total city worker pay—wages plus benefits plus contributions for retirement plans—below the levels anticipated before passage of the measure. In particular, this will require learning to say no to police and firefighters.

Good luck with that.

Expensive Cops = More Crime

The New York Times has a new story linking rising crime in Sacramento to cuts in the local police force. I doubt any reader finds this particularly surprising. Most people assume that putting police on the streets helps deter some crime and results in the arrest of criminals who aren’t deterred, thereby preventing them from offending again.

What the Times doesn’t explain is why Sacramento’s leaders would choose to inflict such a policy on their community. Are they just nuts?

You have probably guessed at least part of the answer. Like the rest of the nation, Sacramento was hit hard by the recession. It was one of the cities at the epicenter of the bursting of the housing bubble. The combination of the two economic blows depressed the city’s property and sales tax revenues, forcing budget cuts.

But another part of the answer is the extravagant level of pay and benefits for police and fire employees.

According to the California State Controller’s database, 168 police employees in Sacramento received in excess of $100,000 in reportable wages in 2010. Most of these also received more than $20,000 in city contributions to health insurance premiums and employer’s assumption of the employee’s share of pension contributions. In addition, 225 of the 446 fire department employees were paid more than $100,000 in wages.

The “why” here is clear. It is difficult for any community to provide adequate levels of police and fire protection when it pays cops and firefighters twice the average wage of full-time workers in the community.

The puzzled readers of the nation’s paper of record would have been well served by this added context.

A Pension Dialogue

Scribbler: As someone who has written a paper about pensions, you must be tremendously disappointed by the pension bill just passed. As our fellow scribblers at the Los Angeles Times said, “Brown’s plan to stem pension costs is no panacea.”

Curmudgeon: Panaceas are as hard to find as unicorns and Mitt Romney tax returns.

Scribbler: But surely you agree with Dan Walters that the “Pension overhaul plan falls short.”

Curmudgeon: That headline is also going to be on Walters’ column the day after the Second Coming. He will fault Jesus for not having returned hundreds of years ago to spare millions from hellfire and damnation, and he’ll scoff that salvation is just a promise, easily revoked when Yahweh throws one of his Old Testament fits of temper, or needs a contribution from the prison guards.

Scribbler: So you think it’s real reform?

Curmudgeon: What is “real reform?”

Scribbler: Don’t go all Socratic on me. Even under AB 340, most public workers in California will have pensions better than most people in the private sector.

Curmudgeon: True. Public workers will still enjoy more security than the huge numbers of private-sector workers who have totally inadequate retirement plans, or none at all. But as Micah Weinberg and I wrote in our paper, taking away retirement security from public workers doesn’t add to the sum of well-being in society. Envy is not reform, it’s one of the seven deadly sins, best cured by repentance and prayer.

Scribbler: Okay, but you agree that pensions are way too expensive, right?

Curmudgeon: If pension costs are your measure, then the bill certainly counts as reform. It reduces the pension formula for new workers, requires employees to pay half the normal cost of pension contributions, caps the size of pensions, and curbs lots of abuses. That will save a lot of money.

Scribbler: But former legislator Joe Nation, now at Stanford and a pension critic, says that “No one should believe that this is going to have an appreciable impact on the public pension problem.”

Curmudgeon: CalPERS actuaries estimate that AB 340 will save the public between $43 billion and $56 billion over the next 30 years. The present value of that savings is between $12 billion and $15 billion, roughly equivalent to what the state spends each year to run the prisons and support the two university systems, UC and CSU. (If CalPERS’s estimates used the low discount rate that critics like Nation trot out to puff up their estimates of the system’s unfunded liability, the present value of the savings would be much larger.) Hobnobbing with the billionaires in Silicon Valley may have warped Nation’s sense of proportion, but like most folks, I still count saving $12 billion as “an appreciable impact.”

Scribbler: So you do, in fact, think this is real reform. How can you say that when the large pensions promised to current workers haven’t been curtailed?

Curmudgeon: And just how might you go about curtailing those pensions? The courts have been firm in ruling that pensions are a contractual obligation that can’t be retroactively taken away.

Scribbler: Pension hawks like David Crane and Joe Nation say that the law isn’t as clear as it appears and that local governments ought to try to convince the courts that reducing future pension accrual by current workers is permissible because the only alternative is deep cuts to parks, libraries, and public safety.

Curmudgeon: If they want to mount a full frontal attack on the machine gun nest, I wish them all the luck in the world. Just remember, though: Judges have pensions too.

Scribbler: What a cynic. So we just give up now?

Curmudgeon: No, not at all. But we ought to try to think more clearly about the real issue here. It’s not pensions. What matters is total compensation for public employees. The public needs to hire people to teach our children, guard our streets, put out our fires. In return for their work, we pay them with a package of compensation, some of it providing them current income, some of it future income: a wage, a health insurance plan, a pension, employer contributions to Social Security and Medicare, and, in some cases, retiree health benefits. As a taxpayer, I don’t care how public workers want to divide that bundle of compensation between current pay and retirement income. I care about the total cost to the public employer.

Scribbler: What’s your point?

Curmudgeon: The point is, if you understand the real issue, it becomes obvious that there may be more promising strategies than attacking the machine gun nest, with its protective legal bulwarks. We can achieve lower total costs more easily by reducing or containing other parts of the package.

Scribbler: Such as?

Curmudgeon: Nation has suggested that California recoup some of those overly generous pensions with a surtax on the pensions of “double-dippers,” public retirees who collect a pension while they continue to work.

Scribbler: That’s all?

Curmudgeon: For years there has been growing concern among budget wonks about the growing cost of, and unfunded liability for, retiree health benefits. Now we have a real opportunity to act. Retiree health benefits are a relic, first authorized in 1961, before the passage of Medicare. Even after Medicare came into being, its benefit package was incomplete, and workers who retired before Medicare age had no assurance that they would be able to qualify for, or afford, coverage in the individual market. The passage of the Affordable Care Act has changed all that. In 2014 every retiree, early or not, will be able to buy health insurance regardless of pre-existing conditions. Obamacare has solved the problem retiree health care benefits were created to address. We can, in good conscience, eliminate them and harvest for state and local budgets the savings made possible by our historic move to universal health insurance.

Scribbler: Doesn’t that create legal issues, too?

Curmudgeon: For people already retired, yes. But there’s no bar to eliminating retiree health benefits for new workers and those for whom they have not vested, either because of insufficient years of service or contractual language.

Scribbler: That’s your panacea?

Curmudgeon: No, you haven’t been listening. There are no panaceas—never are, never will be. Over the last generation, the combination of a broken governance system and public inattention has allowed the total compensation of public employees—and most particularly that of police, firefighters, and prison guards, which is far out of line with national standards—to soar. It will take years of hard bargaining and sustained attention to the issue to bring that compensation back in line. For example, my calculations suggest that the considerable savings achieved in AB 340 would be totally wiped out by a 7 percent pay increase. If we don’t keep watching, the gains will disappear.

Scribbler: Do you really think that the media, politicians, and public in California are capable of that sustained attention?

Curmudgeon: Hey, how about those Athletics and Giants!

Big Pensions, Badges, and Bugles

The number of California public worker retirees collecting pensions of more than $100,000 a year has quadrupled since 2005, Phillip Reese reports in the Sacramento Bee. Unfortunately, his story buries the lede. What's most significant is how many of those big pensions are going to those who wore badges and bugles. A lot of what is seen as a pension problem is really a problem of public safety pay.

Reese is reporting about the number of $100,000-a-year pensions only because the $100,000 pension has been transformed into a political symbol. The California Foundation for Fiscal Responsibility and other groups campaigning to eliminate or modify defined benefit pensions for public employees use $100,000 as a proxy for excess.

What does a pension of $100,000 a year mean? Well, it certainly tells us something about California’s pension system. But it tells us more about the overall pay for particular worker or group of them.

An annual pension is the product of three factors: years worked, a benefit factor (the percentage of wage credited for each year worked), and the salary against which the benefit factor is applied. (To simplify, we’ll leave aside the question of normal retirement age and the size of the reduction for early retirement.) In this equation, you’ll notice, only one of those variables—the benefit factor—is solely determined by the pension system.

If you are a Nobel Prize-winning physician who spends your career teaching at a University of California medical school, you will likely retire with a pension in excess of $100,000 even under a modest pension system with a low benefit factor. That’s because, as the top person in the world in your field, you can command a high salary in the market. You might even earn as much as the minimum for a rookie utility player in major league baseball ($414,500 in 2011). And when you retire, any reasonable retirement plan will deliver a benefit that reflects your lifetime earnings. Certainly few people would find anything excessive about a $100,000 pension in your case.

In other words, to assess $100,000 pensions, we have to know who is on the list and what put them there.

Not surprisingly, California’s list of big pensions is sprinkled with Nobel Prize winners, retired university presidents, and former city managers and other executives at the largest public organizations in the state. Their presence on the list is is mostly a function of the salaries they commanded in the marketplace while they were working.

But a lot of the $100,000 pensions (Reese says “big chunk” but doesn’t give an exact percentage) go to public safety retirees, most of whom worked for local government.

Why? Because California is off the scale when it comes to compensating people with badges and bugles. Police, firefighters, and prison guards come up big on all the variables in the pension equation. They have the most generous pension formula, which allows many of them to retire with 3 percent of salary for each year worked. And they have the highest pay in the country. California prison guards earn 50 percent more than the national average. California police and firefighters earn 33 percent and 22 percent more, respectively, than the national average.

The irony here is that politicians who talk about reforming pensions routinely exempt public safety workers. Meg Whitman, for example, proposed to leave safety employees out from her plan to shift public workers to 401(k) plans. Her plan would have meant less retirement security for teachers, who make up the single largest segment of public employees and whose current retirement benefits “are only modestly higher than the private sector,” according to a recent report from the California Foundation for Fiscal Responsibility, the pension reform group. But it would have left the $100,000 pension club open to police, firefighters, and prison guards.

People in uniform do hard and important work. But their work is not a third or more harder in California than it is elsewhere in the country. In the way it conducts its politics and structures its government, California has let public safety compensation get out of hand.

As Reese’s reporting underlines, that is why the the $100,000-pension club is growing so fast. No pension reform plan can be judged serious if it doesn’t bring that public safety compensation back to earth.

Pension Debate: Think Big Instead→

Over at Fox and Hounds, Joe Mathews complains, rightly, that the California pension debate is “small and boring.” We ought to be thinking about what adequate retirement security looks like for all workers, not just public employees.

In a paper published last year, Micah Weinberg and I did some of that thinking. You can check it out here.