Pension Politics in Pennsylvania

I testified last week in Harrisburg on a 410-page public pension “reform” bill (SB1) that neither I nor my fellow witnesses had read. Normally, we would have been able to rely on actuarial reports, but the actuaries weren’t given enough time to read the bill either. This didn’t stop 28 state senators from passing the bill on a party-line vote without even bothering to hold a hearing (the two I attended—one as a witness—were held by House committees after the Senate vote).

At the first hearing, supporters claimed the bill would help repair Pennsylvania’s credit rating and ensure intergenerational equity. You would never know that the bill actually delays paying down legacy costs. As a result, even the Manhattan Institute’s Richard Dreyfuss (the public pension scourge, not Jaws hero), couldn’t bring himself to support it.

Supporters also claim the bill “preserves current employee retirement benefits,” despite the fact that $13 billion of the projected $16 billion in cost savings comes from changes affecting current employees. At least one of these changes—removing a subsidy for lump sum distributions—might be a good idea in the abstract. But all cuts affecting mid-career workers will inevitably (and probably successfully) be challenged in court, as Dreyfuss pointed out.

The remaining savings come from reducing employer contributions for newly hired workers, even though government workers in Pennsylvania already shoulder more than half the normal cost of their retirement benefits (see here and here). The contributions will go to a 401(k)-style defined contribution plan, a switch that will end up costing more, dollar for benefit dollar, due to transition and administrative costs, as I discussed in a recent briefing paper. In addition, witness Diane Oakley of the National Institute on Retirement Security pointed out that employer contributions to the defined contribution plan vest over four years, reverting to the state if workers leave before vesting. Under the current system, forfeited contributions stay in the pension fund to help pay down unfunded liability.

The higher costs of account-type plans don’t take into account offsetting pay increases or increased turnover. As I testified, most public sector workers accept lower wages and salaries in exchange for better benefits. For most public sector workers, total compensation, including benefits, is lower than what comparable workers earn in the private sector, balanced by greater job satisfaction and security in the public sector. Switching to a less desirable plan would remove one of the incentives that public sector workers have to stay in their positions.

Witness Cathie Eitelberg, a Segal executive and actuary, told the House Democratic Policy Committee that if the bill were enacted employers would not only face the prospect of recruiting new teachers and other workers without the lure of a secure pension, they might also have to stem an exodus of experienced teachers who may view this as an attack on their profession, whether or not they are directly affected. Teacher job satisfaction has plummeted in recent years, and Pennsylvania can’t afford to lose more teachers as budget cuts have reduced education employment in the state by 9 percent since 2010-11.

Meanwhile, the bill’s opponents say the bill reneges on a 2010 deal where unions accepted pension cuts in exchange for a commitment to pay down legacy costs. Not enough time has elapsed to determine how these cuts and the stock market rebound will play out, and there’s no reason to rush to pass legislation that only exacerbates the funding gap.

It’s hard to avoid the suspicion that in a divided state that elected a Democratic governor the same year Republicans made gains in both state houses, the goal for some hardline Republicans isn’t getting the best government they think Pennsylvanians can afford, but tarnishing the government “brand.” Making public service not just un-remunerative but downright unappealing may explain the unusual design of a new cash balance plan the bill would create for newly hired workers. The plan would be funded through mandatory worker contributions earning a minimum rate of return tied to U.S. Treasury bond yields, but capped at 4 percent. Contributions to the cash balance plan would be pooled with existing pension funds and investment returns above the Treasury bond rate but below the expected return on fund assets would revert to the funds. Though investment returns above the 7.5 percent expected rate would be split between the state and cash balance participants, workers would nonetheless be helping employers—and by extension taxpayers—pay down pension promises that predated their hiring. The state would also make money off workers who opted for annuitized benefits.

Even Greg Mennis of the Pew Charitable Trusts, who has rarely met a cash balance plan he didn’t like, had this to say about the arrangement:

“[T]he majority of investment returns above the floor would be retained by the state. We note in our analysis that retirement saving for career workers could be improved upon by sharing investment gains with workers in an actuarially neutral manner, by raising contributions, and/or by providing more favorable terms for annuities than the below market rates proposed by SB 1.”

In other words, with the proposed cash balance plan, the state would be pocketing investment returns at the expense of younger workers. Admittedly, even without the cash balance plan, future workers will pay a price for politicians’ failure to pay their full share of current workers’ pensions. And the cash balance plan in the bill owes its existence more to a desire to keep the pension funds in operation in an unconvincing effort to avoid the issue of transition costs than as a way of making money off unsuspecting participants. Nevertheless, it’s remarkable that the proposed plan’s design makes it difficult for even cash balance plan advocates to support it. As Oakley noted, no one would try to sell a plan this bad in the private sector, which is saying a lot. This brings to mind former Governor Tom Corbett’s failed attempt to shift workers to a 401(k)-style defined contribution plan, when he was so intent on stoking taxpayers’ pension envy that his propaganda touting 401(k)s over traditional pensions sometimes seemed like the reverse.

If the current plan to switch workers to account-type plans makes it through the legislature, Governor Tom Wolf is likely to veto it. But he’ll eventually have to cut a deal with the legislature to move his legislative priority of restoring education funding, which could leave pensions vulnerable. For his part, Wolf has proposed reducing pension costs by cutting fees paid to investment managers.

Wolf also wants to use pension obligation bonds to pay down $3 billion of the $35 billion unfunded liability in the school fund. Pension obligation bonds are criticized for papering over shortfalls and gambling that fund returns will exceed borrowing costs, but the relatively modest size of Wolf’s proposal limits both the potential benefit and the risk. Witness Hank Kim of the National Conference on Public Employee Retirement Systems noted that pension obligation bonds can be designed to tie the hands of feckless politicians (though Kim put it more politely). A recent proposal in Colorado would have included a bond covenant designed to force government employers to maintain contributions into the state pension fund.

Since large pension shortfalls are almost invariably caused by elected officials’ failure to keep up with required contributions, this idea merits a closer look. Recent experience in Pennsylvania, New Jersey and other states shows that benefit cuts made with assurances of responsible funding often lead to more proposed cuts and broken promises rather than a permanent solution. The state Supreme Court in New Jersey yesterday made finding a solution even more urgent by ruling in favor of Governor Chris Christie, who has chosen to renege on a deal he made in 2011, when he promised unions a contractual right to pension funding as a sweetener to help them swallow pension cuts.