How Public Employees and Taxpayers Got Scammed

The politicians are the real problem.


Public employees have been cramming the Wisconsin state Capitol to protest the governor's plan to cut their take-home pay and gut their collective bargaining rights. You can't blame them for objecting when the state reneges on a deal. But they should have been protesting years ago, when politicians and union leaders struck a bargain that was too good to be true.

Government workers have long accepted a tradeoff. They get lower pay than they might get in the private sector, but better retirement benefits. They give up some current luxuries for more security later on. The great majority of them have pension plans with guaranteed payouts—an option that has largely disappeared from the private sector.

Most businesses long ago abandoned defined-benefit plans because they were unaffordable. The public sector has stayed with them, though—apparently to prove those private companies right. State and local governments, according to pension expert Joshua Rauh of Northwestern University, have promised $3 trillion more in benefits than they have set aside to pay for them.

Why? Because there are powerful incentives for both legislators and union leaders to do that. Politicians (particularly, though not exclusively, Democratic ones) want to ingratiate themselves with unions, whose members can be a huge help on Election Day. Union leaders want to keep their members happy and return their favored elected officials to office.

The problem, of course, is that such generosity costs a lot of money, which taxpayers may resist paying. That's where the back-loading of compensation comes in.

Promising government workers excellent retirement plans, off in the future, gratifies union members without outraging the taxpayers. The burden is postponed until some future date, which makes the process painless—until the future arrives.

Wisconsin is a typical state, with more than $45 billion in unfunded obligations by Rauh's calculation. Taken as a percentage of gross state product and state revenue, he informed me, that makes it about average or "maybe slightly worse."

But the phenomenon is a national one. Though Republican Gov. Scott Walker has targeted union negotiations, the same problem exists in states where public employees lack the collective bargaining rights at issue in Madison. South Carolina, Alabama, and Mississippi are among those, and their unfunded obligations loom even larger than Wisconsin's.

If collective bargaining gave too much power to public employee unions, you might expect states that mandate collective bargaining to have lower unfunded obligations—because the unions would be able to demand full funding. But that's not the case.

Union-friendly Illinois is one of the worst states in the country in shortchanging the public employee pension system. Over the years, elected officials have cut the state's contributions, diverted funds to pay other expenses, and borrowed money to cover current pension obligations. But no mobs of teachers and police officers descended on the state Capitol to protest, because they didn't grasp the implications.

Now we can all see the damage done. Though public employees have paid their share, the state has failed to keep up its end of the bargain. So in Illinois, as in Wisconsin and many other places, there is a conflict between what they were promised and what the citizenry is prepared to pay.

Government workers and taxpayers are both victims of this scam, which allowed extravagant pledges that don't have to be redeemed until later—by which time the governors and union officials who devised them are gone, leaving someone else to cash the check.

In the private sector, these shenanigans would never be tolerated. Public pension systems get to assume implausibly high returns on their investments, which gives the impression they can meet their future needs.

The looser rules "allow governments to base their budgets on economic fictions," writes Orin Kramer, who oversees investments for the New Jersey system, in The New York Times. You could even call it fraud.

Republicans in Congress are trying to prevent deception by requiring public pension systems to follow the same basic rules as corporations. Politicians hate the idea for the same reason the rest of us—government workers included—should welcome it. As Moody's Investors Service said in endorsing the plan, it would "provide new incentives to state and local governments to take action to ensure public-employee pension plans' long-term viability."

Creating incentives for governments to behave honestly and responsibly? It's a new concept, but it might be worth a try.