The Washington PostDemocracy Dies in Darkness

State governments could escape crushing pension debts with this one weird trick

Phil Bailey (R) joins a group of labor activists as they rally for jobs and pensions outside Cobo Center ahead of the North American International Auto Show in Detroit in this file photo taken Jan. 12, 2014. (Rebecca Cook/Reuters, Files)

A new working paper suggests a way for local governments burdened by pension obligations to save money while making their employees happier by offering a bonus to workers who agree to give up pension benefits. Many employees would happily make the trade, according to the research by Maria Donovan Fitzpatrick, an economist at Cornell University.

In 1998, teachers in Illinois were given the option to buy additional retirement benefits. For a fee, they could increase the pensions they would receive after they'd retired. The benefits available to individual teachers varied, but from an economist's point of view, the offers were a bargain. Even after taking interest rates into account, the additional money in the future would be worth far more than what teachers would have had to pay at the time. They left the money on the table. Fitzpatrick found that if the state was offered benefits worth an immediate $1,000 (increasing in value over time), a typical teacher wouldn't take it unless they could get it for $200.

That might sound crazy, but it isn't. Compared to their counterparts in the private sector, teachers have generous pensions, but their salaries are lower by some measures. It might make sense for a teacher to insist on more money up front -- particularly if she's got a mortgage to pay off or a child to send to college. Often, teachers have a defined-benefit pension, which, since it pays a fixed amount every year during retirement, isn't worth all that much to someone who dies soon after retiring. Teachers might want to protect themselves against the risk of an early death by investing the money in some other kind of fund.

That isn't to say that all the money spent on teachers' pensions is wasted -- teachers want to save some money for retirement, just like everyone else. Fitzpatrick's calculations do suggest, though, that if a district or a state is considering an increase in teachers' pensions, they should increase teachers' salaries instead. In fact, they could raise teachers' salaries for a fifth of the cost and make teachers just as happy. Alternatively, they could pay just as much, but put all of the money toward salaries. The result, Fitzpatrick's math shows, would be to make teaching much more attractive to talented workers and improving the quality of instruction in schools at no extra cost.

Put another way, local governments without the money to meet their pension obligations should consider buying back retirement benefits from public employees and pensioners. They could offer, say, a $200 bonus for every $1,000 in benefits, adjusted for interest, that a worker or a retiree agrees to give up. Everyone would be better off. Working employees would get money they need right away. Retirees who don't want to give up pension benefits, as they've agreed to do in Detroit, might not have to sacrifice as much. Taxpayers would save money. It would be important, of course, to offer employees some financial guidance, so that they don't take their bonus and invest it unwisely.

Buy-back programs already been tested in the corporate sector. Ford saved $4.2 billion through an offer that 35,000 former employees accepted in 2012. Until now, as society has aged and confidence in the stock market has broken, governments and corporations simply haven't worried too much about funding their pensions.

"There's no reason to think this couldn't also work in the public sector," Fitzpatrick said. "It is a very new idea, even in the private sector."

In practice, though, policymakers often feel that they don't have a choice between salaries and pensions. They're worried that if they raise salaries, they won't be able to balance next year's budget. Promising increased pensions has been a way to kick the can down the road; governments now contribute, on average, three times as much to pensions per hour of employee labor than private firms.

Fitzpatrick worries that if governments, such as in Detroit and Stockton, Calif., can't keep their pledges to retired teachers, students will be the ones to pay. Talented and qualified people will increasingly consider other careers. "Over time, the quality of teachers that we’re getting in the classrooms will erode," Fitzpatrick said.

"One of the reason that teaching has been attractive was that even though it was a low-salary profession, it came with a package of generous, secure benefits," she said. Now, those benefits are proving to be less than secure. Everyone might be better off if we just gave teachers the money.