Why municipal workers should let go of the defined-benefit pension mirage

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Retirees in Detroit are about to take a loss on their pensions. A big loss. The so-called “defined-benefit” pension is turning out to be anything but. The collapse of the defined-benefit promise is not going to stop in Detroit. It is only a matter of time before it reaches Pennsylvania and Pittsburgh. The Ravenstahl administration may have been able to put off the reckoning with its parking authority accounting gymnastics, but not forever.

The fact is that Detroit and hundreds of other communities across the country simply cannot and will not fulfill their future pension liabilities. If you are a state or local government worker, you should be preparing yourself for a much lower payout than you were promised. Even economically stable cities like San Jose, Calif., are staring default in the face.

Laying blame for America’s municipal pension mess is like figuring out who the murderer is on the Orient Express. Everybody did it.

Politicians made promises they knew they wouldn’t have to keep. Union leaders bargained for every last dollar, regardless of whether cities could actually pay up. Bond buyers took an extra slice of interest while whistling past the graveyard. And voters weren’t paying attention at all. The end result is that the so-called defined-benefit pension is evaporating for a growing number of retirees.

The heart of the problem comes out of politics.

The politicians who negotiated the pensions were concerned with re-election, not with the bill that would come due in the future. It was easy for them to make promises for payments 20 years down the road when they knew they would not be in office and responsible for those promises.

Overpromising was only the first step. When faced with rising costs, these same politicians could either cut services or raise taxes. Instead, they chose the third option: cook the books.

If a city needs $100 million in 20 years it will have to set aside just over $2.5 million per year with a conservative 6 percent rate of return. But, if a city assumes an 8.5 percent rate of return, it can cut that payment by more than $600,000, or 25 percent. Of course, assuming 8.5 percent is simply absurd, but financial chicanery beats out tax hikes and spending cuts any day of the week.

Today the political calculus has changed. With pension funds going broke, present-day politicians have nothing but bad choices. They can raise taxes, cut services to the bone or walk out on the pension obligations.

Since pensioners and municipal workers are a smaller voting bloc than taxpayers, they are going to lose out. Today’s officeholders didn’t make the pension promises, which makes it easier politically for them to walk away.

While pensions are not going to zero, they will fall. The defined-benefit guarantee is going to founder on the rocks of political reality. Relying on the promises of politicians is a risky game, but relying on future politicians to keep the unrealistic promises of past politicians is a losing game.

There is certainly no evidence politicians are evolving toward keeping their promises. If anything, they are evolving toward more creative ways of denying economic reality.

The mistake that municipal workers and their unions are making today is failing to learn from this debacle. As great as defined-benefit pensions sound, they are only as secure as the finances and political will of the future.

Labor unions and their members who are relying on state constitutional guarantees are just fooling themselves. Already the city of San Bernardino, Calif., is simply refusing to pay into the California pension system. When the political pain becomes intolerable, the government will just change the rules.

The smart strategy would be for workers to shift to defined-contribution plans. Given the poor track record of individual investors, the pension plans could be designed to automatically make investments, subject to a specific set of rules.

The pension contributions by the local government would be defined and due each year, leaving politicians of the present and future unable to cheat the fund with accounting tricks and unrealistic assumptions. Even if a city goes bankrupt in the future, the workers will have something in their accounts.

The fact is, there is no such thing as an ironclad promise of defined benefits in retirement. The defined benefit is contingent on the fiscal health of government in the future.

The benefits municipal workers have been counting on are turning out to be a mirage. The best thing for them is to walk away from the defined-benefit fantasy and take control of their own retirement funds.

Keith Naughton, a former Republican political consultant in Pennsylvania, is about to complete a Ph.D at the University of Southern California.


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