If you are an informed, fair-minded person, chances are you feel at least conflicted about all the hard-knuckle attacks on public employee unions in Madison, Wisconsin, and other state capitols. While Governor Scott Walker's agenda was clearly much larger than balancing his current budget, there is no denying the magnitude of the pension crisis. Long predicted, it's finally here, and it's constricting the art of the possible in almost every state.
California finds itself paying more for benefits to public workers' pensions than it does to fund higher education. And because public employees now on the job keep accruing new, underfunded retirement benefits, the pension debt keeps growing. Despite having some of the most underfunded public pensions in the country, Illinois will reduce its pension trust holdings this year to meet its pension payroll. One study suggests it will exhaust its assets by 2018 and finds that New Jersey is close behind. In places like Indiana and Louisiana, where policymakers have been making added pension contributions to cover past underfunding, they are still losing ground. Perhaps needless to say, any money that state and local governments use to bail out their pension plans can't be used for any other purpose. Not only is that money needed to replace the teachers and police officers now retiring in their fifties; it could also be spent on exploding costs for health care and other pressing social needs.
Yet many Americans are uncomfortable with the solution being pursued by Governor Walker and some of his Republican counterparts, which boils down to busting public employee unions. Whatever the faults and excesses of some unions, polls confirm that most of us support a basic right to collective bargaining, even in the public sector. It's one thing to, say, criticize the opposition of some teacher's unions to merit pay or demand that firemen contribute more to the cost of their own pensions and not game the system, and quite another to assert that teachers and firemen have no right to organize and communicate their grievances collectively to their employers. Article 23 of the Universal Declaration of Human Rights identifies trade union organizing as a fundamental human right.
There are also political considerations that factor into the discussion. Many people are concerned about the ramifications of the Supreme Court's Citizens United decision, which struck down any restraint on political spending by corporations and wealthy individuals to influence elections. Not only partisan liberals fear that, without a counterbalance, there will be no effective check on the power of well-heeled corporations in either party. Public-sector unions can serve as an important element of this counterbalance. At the same time, however, nothing could be more toxic for the Democrats than insisting that ordinary taxpayers fund pensions that are far more generous than what most can ever expect to receive themselves.
The problem doesn't just involve the egregious cases that grab headlines, such as the small-town California fire chief described by the Wall Street Journal who was able to retire at age fifty with a pension of $241,000 a year—and who was then hired back as a consultant at $176,400 to help find his replacement. Even the pensions received by ordinary government employees are practically unheard of in the private sector these days, particularly among younger Americans.
Outside of government, only about 15 percent of private workers are covered by a defined-benefit pension, and even those are not as generous as those enjoyed by public workers, which promise to replace a substantial portion of their final salary for life regardless of market conditions and are often adjusted for inflation as well. It would be great if someone had a credible plan for offering every American that kind of retirement security, but no one does.
Public employees sometimes complain that they receive lower salaries than their counterparts in the private sector. That's often true, but when the value of their pensions and other benefits are factored in, their total compensation, especially for blue-collar jobs, is frequently at least competitive, if not superior. Proof of this is how few public employees quit. It's telling that workers in the private sector, according to the Bureau of Labor Statistics, are more than three times more likely to quit their jobs than state and local workers, whose monthly turnover is just .5 percent.
But the preferred solution by some policymakers— bust the unions—isn't the appropriate response. That's because it doesn't address the core problem, which predates collective bargaining in the public sector and is found even where unions don't exist. Instead, the real problem is something no one wants to talk about precisely because it's so bipartisan: both political parties, for different reasons, have incentives to use pensions as ways to borrow from the future. The way to fix, or at least alleviate, this problem is not to take rights away from unions. It is to give more power to voters.
There's plenty of blame for the pension crisis to go around, but no particularly good reason to blame only the unions. Military retirees, after all, don't have a union, and yet the cost of the pensions promised to them by Congress over the years now comes to $1.3 trillion, or $10,700 for every U.S. household. Similarly, long before most federal workers earned any formal right to collective bargaining under the Civil Service Reform Act of 1978, the Civil Service Retirement System, created in 1920, was amassing huge unfunded liabilities for which we are still paying now. Today, the handful of states that don't allow collective bargaining among their public employees generally have benefit plans that are just as generous as states that do allow it. One of those nonunion states, Virginia, faces $17.6 billion in unfunded pension liabilities.
Consider as well that by the late 1920s—a time when unions still had almost no toehold in government employment and were often violently repressed—all major cities in the United States had pension plans for either policemen or firemen or both, and twenty-one states had formal pension plans for their teachers. These plans were far more generous than what was typically found in the private sector, where most workers got no pensions whatsoever. And without the meddling of union bosses, public-sector plans were almost universally mismanaged and underfunded, if they were funded at all. In Massachusetts, pension assets simply consisted of "such amounts as shall be appropriated by the general assembly from time to time." As economic historian Lee Craig has documented, other states and municipalities pretended to fund the pension plans simply by having them purchase their own bonds, meaning that the pension fund's so-called assets were in fact being used to meet the other costs of government, such as paying off favored contractors. Already actuarially unsound, and with their so-called assets already spent, most failed or had to be bailed out in the 1930s.
The real cause of the crisis is the inherent conflict of interest politicians face when they have the option of handing out or maintaining pension promises to favored constituencies, including themselves, without the public understanding what's going on and without the bills coming due until after they are gone from office. Politicians have two basic ways of doing this. First, they can, as Republican Christine Todd Whitman and subsequent governors of New Jersey did, simply stop contributing money to the pension fund or tap their credit card to pay the pension mortgage. This is especially easy to pull off during periods of irrational exuberance. In 1997, Whitman had New Jersey borrow $2.7 billion in pension obligation bonds on the assumption that the state could use the money (or what was left of it after the tax cut Whitman had promised in order to win the election) to make a big kill on Wall Street. When New Jersey's investments went south, it was stuck not only with the cost of servicing the bonds, but also with a giant hole in its pension fund. Illinois did the same thing in 2003, by borrowing money from Wall Street at 5.5 percent on the assumption that it could make 8.5 percent by investing it on Wall Street. Predictably, this Wizard of Oz fund-raising hasn't worked out. In December 2010, Illinois's then comptroller, Dan Hynes, was on a segment of 60 Minutes saying that he had $5 billion worth of bills in his office and no money to pay them. Unable to even pay its other bills, Illinois is now proposing to issue another $3.7 billion in bonds to make this year's pension contribution.
Politicians can also make benefits more lush without coming up with the money to pay for them. That's what happened in California in 1999 under Democratic Governor Gray Davis, when the state enacted the largest pension increase in its history—one that now has become the single biggest threat to the state's continued solvency. For regular employees, the legislation reduced the age at which unreduced benefits could be claimed, from sixty to fifty-five. For highway patrolmen, it left the age for claiming unreduced benefits at age fifty but sweetened the benefit formula by 50 percent. For peace officers and firefighters, the new enriched formula applied at age fifty-five and after. The bill also provided an added cost-of-living adjustment on top of the annual adjustment built into the existing system.
Who was responsible for figuring out how much these other technical changes in the big benefits bill would cost? Why, the actuaries employed by the California Public Employee Retirement System, of course—whose own pensions would be enriched by the legislation they were being asked to evaluate. Not surprisingly, the actuaries declared the bill easily affordable, though in fact, as we now know, they underestimated its cost by a factor of five.
And who made the final decision? Why, the members of the California legislature, Republicans and Democrats alike—who, like the actuaries, would see their own pensions increased by passage of the bill, and who would win votes from public employees if they voted yes. The pension bill passed 39-0 in the state senate and 70-7 in the assembly, while barely making the papers. As far as the average Californian could tell, the big news out of Sacramento that day was passage of a bill to provide gay students legal protection against abuse and an agreement to allow expanded Indian gambling operations around the state.
So this is the world as we find it. Government decisionmakers face an inherent conflict of interest when it comes to making pension policy for government employees, and so do their staffs. This is true whether or not unions are involved. Beyond the enticement of self-dealing is the temptation to self-aggrandizement that comes when politicians are allowed to take credit for delivering benefits whose full cost only becomes apparent after they are long gone. That all this can be done within a tight circle of insiders without the press or the public taking much notice only further perverts the logic of decisionmaking.
There is another realm of government where much the same misalignment of incentives applies, and what we do to check against it suggests an answer for how to deal with the pension crisis. When a city or state is considering whether to float bonds to finance a major project, like building a school or a highway, the rule almost everywhere is that the issue has to be approved by referendum. In Wisconsin, for example, no school board can commit to a capital project of more than $1 million without taking it to the district for a vote. That's because otherwise there is too little check on politicians borrowing from the future to benefit their favorite contractors and other constituents. With so much backroom self-dealing possible, sunshine and direct democracy are a necessary corrective.
We could easily apply the same rule to public employee pensions. Let the unions and the politicians negotiate all they want, but if they come up with a contract that puts future taxpayers on the hook for the cost of making pension and other retirement benefits more generous, it should go to a vote of the people. If the people are feeling generous, or if they feel there is indeed a strong case for why public employees need more generous pensions, they may well go along. If they feel there are more compelling purposes for which they should be spending their own or their children's money, they will not.
Just by being on the ballot, these questions would attract more press attention to the issue of pension finance, give a greater platform for government watchdog groups and disinterested pension experts, and promote better public understanding generally of the trade-offs involved, all of which is sorely needed. The League of Women Voters would print brochures explaining the pros and cons. Newspapers would weigh in with editorials. In contract negotiations, politicians and other insiders would know that whatever deal they struck would have to win a majority vote of the people—who will ultimately have to pay the bill. It might mean that public employees wouldn't see another pension hike for another generation. So be it. That would give the majority of Americans who lack pensions some time to organize and catch up.
Referendum is, of course, not a perfect solution. By itself it does nothing to reduce the cost of the pension promises already made, many of which are protected by state constitutions as well as ordinary contract law. (Eliminating collective bargaining rights for unions won't solve this problem, either.) It's also important to apply the same strict regulation regarding how liabilities and rates of return are calculated in public-sector plans as is now generally found in the private sector. But going forward, subjecting pension enrichments to the vote of the people would both grant public workers the right to collective bargaining while also giving much stronger protection to the public from existing moral hazards we can no longer afford to ignore.