Pensions squeeze government budgets

March 25, 2011

PUBLIC-SECTOR PENSION wars are breaking out across the political landscape. Republican Gov. Scott Walker’s effort to rein in state and local employee pension costs is central to his explosive battle with unions in Wisconsin. In Costa Mesa, Calif., a GOP mayor has issued layoff notices to nearly half of that city’s 472 employees, arguing that the only way to pay for pensions is to cut current services. But this is not just an issue for Republicans. New York’s new Democratic governor, Andrew Cuomo, also is calling for pension reform. In our region, Montgomery County Executive Isaiah Leggett (D) wants workers to increase their pension contributions by 2 percent of their salaries, despite an arbitrator’s ruling to the contrary.

Plainly, the hardworking men and women who provide public services — from librarians to firefighters — deserve appropriate compensation. Just as obviously, the hardworking people who use public services can only afford to pay so much in taxes. For many years, politicians have finessed this trade-off by negotiating bigger pension benefits for unions; they can take credit for treating employees well, and let someone else worry about paying for it later on. But in the wake of the stock market collapse of 2008, that strategy has been exposed as unsustainable.

Indeed, matters may be even worse than they already seem, since public-sector pension plans typically incorporate optimistic assumptions about the returns they will earn on their investments. It’s another way for governments to make deferred compensation for employees seem like a free lunch for taxpayers. Eighty-eight of the 126 largest public pension plans assume a rate of return exceeding 8 percent a year, according to the Wall Street Journal. By way of comparison, the S&P 500 achieved a compound average annual growth rate of 5.69 percent over the past 20 years.

Virginia’s state retirement system recently lowered its assumed rate of return from 7.5 percent per year to 7 percent. Maryland’s fund still banks on 7.75 percent. In California, elected officials recently blocked a recommendation by the actuary for the giant California Public Employees Retirement System to lower that $227 billion fund’s assumed return rate from 7.75 percent to 7.5 percent. The obvious reason: To do so would have exposed the emptiness of their past promises — and forced them to contribute more money in the here and now.

No one wants pension plans to overfund themselves, which could happen if they adopted overly conservative assumptions. But with so many systems well below the minimally prudent 80 percent funding rate, even with optimistic investment assumptions, that is hardly the most pressing danger. States need to act on the big lesson of the last few years of financial history: Life is full of surprises, and not all of them are pleasant.

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