I want to talk to you about three words that
should scare the heck out of you, especially if you’re young: public pension liabilities.
Okay, I know you probably have about a hundred things you’re worried about, and public
pension liabilities likely aren’t one of them. But that’s the reason this is so scary—because almost no one is paying attention.
Unless you’re okay with your city going full Detroit and giving more of your hard-earned
money to pay off someone else’s debts, stay with me. So what is a public pension liability? A pension is a guaranteed, lifetime payment
to someone after they retire. Pensions used to be a big deal in the private sector. Every
major American company had them. But they became too expensive, and companies have taken
steps to phase them out. However, pensions still live on in the public
sector—among employees of the government— and they’re eating city and states’ budgets
alive. More and more money that could go to tax cuts or better services is instead
being shoveled aside to pay for these benefits. Why is this happening? Over decades, politicians
have promised trillions of dollars in pensions to government workers. That includes police,
firefighters, teachers, and city and state officials. You name a government job, and
there’s a pension associated with it. Now, you may be wondering, “How big are
these payments?” Many pensions are quite large. In California, more than 62,000 retired
public employees are receiving pensions of over $100,000 per year. Sometimes, it’s
even crazier. A retired New York City sanitation worker is getting $285,000 per year. A retired
county administrator in California receives over $400,000 per year. Remember, these are guaranteed lifetime yearly payouts. Now, we love our public employees. They do vital work for our local communities and the
wider society. They deserve competitive pay and retirement benefits. But currently, many
cities are, in effect, paying for multiple public departments at the same time: the department
that’s working now and, because people are living longer, a generation or two of retirees.
The system amounts to a self-perpetuating, corrupt merry-go-round. Public-sector unions
give large donations to candidates, who are then responsible for negotiating how much
of your money goes to public sector workers. These arrangements not only promise high salaries
in the short-term, but they also hide the payments that will be due down the road when
it will be much too late. The results are predictable.
State and local governments across the U.S. openly admit to 1.4 trillion dollars of unfunded
pension liabilities, or $11,000 per household. “Unfunded” means dollars that have been
promised, but there’s no actual money in the bank. And that’s just the amount they
admit to. The real number, according to the Federal Reserve, is much larger—around 4
trillion dollars, or $32,000 per household. Pensions have already thrown California cities
like San Bernardino and Vallejo into bankruptcy. And the entire state of Illinois is teetering
on the edge. So how do politicians get away with this?
They use a time-tested political strategy: they lie. They lie by saying they can pay for more and more generous pensions—not by collecting
more taxes, but by making investments at a “guaranteed” 7.5% return.
But this is nonsense. It’s less and less likely they’ll meet their 7.5% goal over
time, and their investment behavior—pouring ever more funds into ever riskier investments—suggests
they know it. But if they were to use a more realistic assessment, they’d need to raise
taxes dramatically. And they love their jobs too much for that. We can, however, turn the odds in our favor—with public pressure, discipline, and common sense.
Here’s what needs to happen: First, we need state and local governments
to report unfunded liabilities honestly: the real numbers—using the 2-3% yields that
sound financial reporting would require. No more pie-in-the-sky stuff. The truth should
shock voters into demanding action. Second, we must phase out the guaranteed pension
programs as quickly as possible and introduce 401K plans. 401K plans, if designed properly,
can provide excellent retirement benefits. These plans also have the advantage
of being portable. If you leave the public sector and go work in the private sector,
you get to take your money with you. In other words, you don’t have to be locked-in to
a lifetime government job to receive retirement benefits. Win-win.
Let’s end the current structure of public sector pensions and move to a sustainable
way of compensating our public workforce. Save your city.
Save your state. Save your money.
I’m Joshua Rauh, professor of finance at Stanford and Senior Fellow at the Hoover Institution,
for Prager University.