American Interest

Desperate Pension Funds Mull Buyouts

Ravenel B. Curry III Distinguished Fellow in Strategy and Statesmanship

Some of the nation's most overburdened state and local governments are considering an unprecedented strategy for defusing their public sector pension time bombs: Offering workers lump-sum payments worth somewhat less than their pension guarantees in the hopes that enough will accept to meaningfully reduce long-term costs. Governing magazine reports:

In Philadelphia, where the municipal pension plan is less than half-funded, Controller Alan Butkovitz is pushing a buyout of sorts aimed at the city’s most expensive workers. In exchange for taking an upfront cash payment based on their estimated lifetime benefits, the employee or retiree would accept a reduced level of pension benefits going forward. The benefits would be equivalent to what newer Philadelphia public employees are receiving now. […]

In Illinois, where courts have ruled against any changes to retirees’ payments, lawmakers have contemplated lump-sum payouts to reduce their unfunded pension liability. The state’s public employees plan is currently 34 percent funded.

The resolution to America's multi-trillion dollar public sector pension problem will have many elements, and buyouts of this kind will likely be a part of it.

But the problems with the current pension system go deeper than the simple fact that they can only be honored, if at all, with tremendous difficulty and sacrifice in many places.

First, there is the moral hazard problem: The easiest way out of collective bargaining issues for both politicians and union leaders is to promise increases in pension benefits down the line, but not to set aside enough money to pay them right away. This creates a "victory" for union leaders, who look strong to their members, and for politicians, who get union support but don't have to annoy the public by by raising taxes or cutting other spending. Everyone is happy—until the merry-go-round stops spinning.

But there's more. The defined-benefit pension system is designed to lock employees in place. Workers sometimes need to remain in the civil service for decades to become eligible for benefits. That's one reason that unions fight so hard to make it very difficult to fire public employees, whether they are teachers or cops. Reforming this system, and making the public sector workforce more flexible and merit-based, would likely improve the quality of government service.

Finally, the pension problem is also exacerbated by economic and demographic population shifts within the United States. Financially-struggling Detroit and New Orleans, for example, used to be much larger cities than they are now. (This is also true of Philadelphia and Chicago, albeit to a lesser extent). When cities with large bureaucracies serving large populations downsize, they are stuck with pension bills incurred in different times, and with fewer taxpayers to pay for them.

The shift to defined contribution, 401(k)-style systems (which ought to be generous and offer real incentives so that workers can really build assets and wealth) is a way to make cities better run and their finances more secure. Unions will make every effort to propagandize against this shift, but the sooner policymakers bite the bullet and make this shift, the fewer impossible choices they will face in the future.