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Policy Summary

Many workers opt for public sector jobs lured by generous pensions and other benefits such as healthcare and leave time.  Private sector work may offer higher salaries and some benefits but they are much less likely to offer guaranteed defined benefit retirement plans. These refer to a guaranteed payment, often for life, based on formulas computed with age and years of service.  Contributions are made from the employees’ salaries as well as by the agency.  These pensions are guaranteed untouchable by states laws which protect their future.  If revenues fall, the employers must absorb the risk and contribute more to compensate for the shortfalls.  In the public sector 77% of employees enjoy defined benefit pensions in contrast to only 13% of private sector workers.  The situation is different in counties and municipalities which become vulnerable to some reductions if they enter Chapter 9 bankruptcy.  In defined contribution systems, the employee and employer pay into the system but there is no guaranteed payout and the employee assumes the risk. More companies are shifting to these programs and government may follow this path, too.

Economists have been sounding the alarm, for years, regarding the shortfall or gap between pension obligation and available assets.  This is true in all pension plans, to a greater or lesser extent, from small local entities to the California state employee system, Calpers, which services 1.6 million employees.  Economists have been warning pension administrators of demographic shifts leading to the decreased contributions from contracted workforces paired with growing numbers of retirees.  The pandemic has accelerated this change leading to greater deficits from unemployment and revenues lost when businesses shut down.  State and local pensions have seen a loss of one trillion dollars since mid-February.  California, for example, has seen a loss of 69 billion dollars in their 404 billion dollar portfolio, compounding a shortfall already predicted by the state budget offices.  Overall, estimates suggest an immediate state revenue gap of 650 billion dollars.  Although state pensions are predicted to be stable, due to law and political pressures, some localities such as Detroit, were forced into reducing payouts as a consequence of Chapter 9 bankruptcy restructuring.  Experts have been cautioning pension planners to shift form high yield to conservative investments but these warnings have gone unheeded.  In 2019, state and local pensions averaged a 71% funding level but this is predicted to decrease to 62.7% in a healthy recovery and 55.5% in a sluggish one.  Many entities have relied on “gimmicks” such as short term loans, tapping reserves, and/or deferring some costs to cover their obligations. Ultimately, these will exacerbate the problem by delaying a longer term solution.

Policy

Suggestions regarding changing investment patterns to solidify the available assets and minimize risk are rational but unlikely to meet the need of the changing ratios of active workers to retirees.  It is possible that future public sector employees will not be offered defined benefit pensions.  In recent years, increases in pensions and healthcare costs have been favored by unions as these benefits are not subject to income taxes though they are severely impacting government budgets.  Some states are closing their pensions to new workers while others are increasing the employee contribution.  In Kentucky, a state with a steep shortfall, teachers are now contributing 13% to their retirement, twice as much as their social security payroll tax.  Other states, such as Illinois, have added a 3% tax compounded annually, an amount which exceeds inflation.  Other remedies have been doubling the gas tax; tripling the real-estate transfer tax; increasing car registration; increasing car metering costs; legalizing and taxing marijuana; and instituting a property fee which is levied on all entities including schools and churches.  These actions have cost the state some of its population.

Increased employee contributions to public systems are feared to discourage people from entering the public sector as teachers, firefighters, law enforcement, or agency workers.  Post-pandemic restructuring of government agencies is predicted to reduce the number of public employees, further cutting into available revenue. The federal government should be providing aid to ailing states and local governments but it not moving in that direction. Mitch McConnell (R), the Senate majority leader has stated that Congress should move to allow state bankruptcy rather than depend upon federal aid.  The short sighted management of pension funds was already putting these at risk prior to the pandemic.  Now the issue is accelerating and attention should be turned to redesigning  government polices with regard to pensions, social security, and employment.

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