"We have opened up a new sport for America's elite," economist Dean Baker shrilled in a widely circulated December 2013 column for truthout.org. The sport? "Pension theft." Baker is panicked, like so many on the left, about the prospects for public sector pension benefits in cities where legislators are facing bankruptcy and starting to make hard decisions about trimming benefits for future government employees. Cutting pension payouts instead of raising taxes to pay for the underfunded promises, Baker argued, is tantamount to stealing: "Rather than inconvenience all those rich folks at the Chicago Board of Trade or other highly successful businesses with a larger tax bill, the plan is to stiff the firefighters, the schoolteachers, and the people who collected garbage for 30 years."
The fights over who is going to get paid and who is going to get screwed in fiscally distressed cities can seem like a game, albeit one with wildly arcane rules. But it's the public sector unions—especially the ones representing police and firefighters—who are the most adept at playing it.
Baker is peddling nonsense, but he is inadvertently right: There has been a massive theft, totaling hundreds of billions of dollars. But the real victims of pension graft are current and future taxpayers, who face ever-higher taxes and ever-lousier public services. The beneficiaries of this gravy train are the very people whose plight Baker bemoans: public sector workers.
Thanks to the pension-hiking bonanza of the last two decades, the public sector pension system, even in a time of rising municipal bankruptcy, is a massive redistribution of wealth from the young to the old. It also is a transfer from some of the nation's poorest residents to some of the nation's best-paid retirees. The few pension reductions that legislators have passed across the country have mostly been for future employees, not current recipients. The very fact that unions are getting hysterical about new hires being offered a slightly less generous benefits package demonstrates just how unmoored the debate over pension reform has become.
The Illinois Supreme Court tossed the state's efforts to slightly trim pensions for current employees. And only one bankrupt city is cutting vested pension benefits for current retirees. That's the post-apocalyptic crime scene of Detroit—and even Detroit's emergency manager is executing just a modest trim, a 4.5 percent cut of current pensions and reduced cost-of-living increases. While those pensioners are certain to be less than thrilled about having their promised payouts crammed down, what's happening to them is also happening to all of the city's creditors. It is "theft" only to the degree that all bankruptcies deprive some people of the full amount they are owed. Indeed, some bankrupt cities' creditors are recouping only pennies on the dollar from their investments, while pensions remain completely untouched.
Kids Pick Up the Check
Occasionally, a city will try to reduce benefits and pay when in extremis. In 2012, the mayor of Scranton, Pennsylvania, cut his city workers' pay to minimum wage for a while when the city went broke. The firefighter, police, and public works unions then took the city to court and won, but the mayor still didn't have money to pay them. (Eventually, the state provided a bailout.)
But such direct confrontations between elected officials and unions are rare. Mainly, despite heavy breathing from the likes of Baker, politicians shower largesse on powerful union members and impose debts on future generations.
That's how the defined-benefit pension systems that the public sector demands are designed. In the private sector, employees typically receive defined-contribution plans (e.g., 401(k) accounts), to which employees divert a portion of their paycheck. Sometimes the employer matches a portion of the set-aside. The money is invested in stocks, bonds, or other instruments. When the funds do well, the savings grow, and vice versa. Upon retirement, that employee receives the proceeds in the account. It's pretty simple and devoid of accounting gimmicks or hard-to-tally future debts and liabilities.
Most government employees—and in the old days, many workers for major corporations—receive defined-benefit plans. They are guaranteed a certain level of payout based on a formula. Pension funds invest the money contributed by the employee and employer (in many systems, the government employer makes the entire contribution); those funds then make a prediction about the system's overall rate of return. When the market is booming, the unions say that there's plenty of money to go around and lobby for richer benefits. When investments don't do well, "unfunded liabilities" go up and legislators put more tax dollars into the system—or worry about it later (or in some extreme cases, never).
It isn't quite a Ponzi scheme like Social Security, but the defined-benefit system does foist massive "unfunded" obligations on future generations. It privatizes gain (workers enjoy the benefits in good times) and socializes risk (taxpayers are on the hook for shortfalls). And these pension promises are given a privileged status at the top of a government's list of obligations: Virtually everything else must be cut first if the money ever runs out.
"This is your issue," California Pension Reform President Dan Pellessier recalls telling a group of students who were touring the California Capitol a few years ago. "This system is accumulating bills you and your children are paying off. This is where you should apply your efforts."
The system's intergenerational wealth transfer has come to the fore in recent months. In November the Board of Regents of the University of California (UC) voted 14–7 to raise tuition by as much as 5 percent a year unless the state legislature provides it with at least $100 million more a year. This after tuitions already doubled over the past decade.
While UC President Janet Napolitano touted all the new programs and students the tuition increases would fund, closer analyses found that something else (aside from the usual bureaucratic bloat) was driving the hefty increases: unfunded pension liabilities and soaring health care costs. "The UC system is notorious for its two-decade long pension contribution holiday, during which it failed to contribute to its retirement systems," explained the reform-oriented group California Common Sense, founded by Democratic pension reformer and Stanford lecturer David Crane.
In the late 1990s, the university had surplus assets and decided to just stop making its annual contributions to shore up its pension fund. It instead relied on optimistic predictions about its investments' rate of return. The returns fell short, and now the system is underfunded. "The UC also failed to set aside almost any assets to prefund its retiree healthcare plan, which has a funding ratio of just 0.3 percent," the California Common Sense report concluded.
Of the 10,000 California state employees who earn more than Gov. Jerry Brown, more than 7,000 of them work in the University of California system. So students will go more deeply into debt, in part to pay for an older generation of well-heeled retirees—a transfer of assets that will affect most students' long-term bottom line, given that 55 percent now graduate with college-loan debt. It's not fair, but it's endemic in the nation's entitlement system.
As funding levels fall off, older workers often throw younger ones under the bus. Sometimes the bus cliché is almost literal. In one contract negotiation I covered in Orange County, California, in the mid-2000s, the bus drivers' union—controlled by senior drivers nearing retirement—backed a contract that boosted their retirement benefits at the expense of entry-level pay to help offset the costs. It's not unusual for union negotiations to turn into generational warfare.
Younger folks are starting to see how ugly the picture is. A snarky Philadelphia magazine column from 2013 was titled: "Baby Boomers: Five Reasons They Are Our Worst Generation." Three of those five reasons involve debt spending. "The boomers have created liabilities that will take generations to pay off," wrote Gene Marks.
The beneficiaries of the current system peddle emotional falsehoods to keep the younger generation from looking too closely at the numbers. For instance, police officers and firefighters trumpet the myth that they deserve to receive such large pensions because they don't live long after retirement. Should thirty-something workers be crass enough, they ask, to deprive these heroes of a few years of comfort after a life of public service?
This is buncombe. The nation's largest state pension fund, the California Public Employees' Retirement System (CalPERS), has been a muscular advocate for California's mad pension-increasing spree since the late 1990s. But the "we die early" arguments were too much even for CalPERS, which, despite its union advocacy, is a font of useful actuarial data.
The fund in 2008 produced a report debunking various pension myths. Myth No. 4: "Safety members do not live as long as miscellaneous members." In fact, most public-safety officials (police, firefighters, prison guards, etc.) retire in their early 50s and live into their mid-80s, the report found. The longest-living category of public employee is a police officer, followed by a firefighter. A 65-year-old male "safety" retiree is likely to live until almost 83, and his female counterpart will make it past 86. It's wonderful that these folks are living long, healthy lives, but 35 years of taxpayer-funded retirement seems excessive.
And the obligation doesn't always end when the retired firefighter finally ascends the big extension ladder to heaven. One actuary jokingly tells me about a new term, "the Viagra Effect." Pensioners are living long lives. Male retirees often marry much younger wives, who can receive spousal benefits for many decades. Actuaries need to account for this.
Baker and other pension advocates argue that the average public sector pension is only $33,000 in Illinois and $18,000 in Detroit. This is true but misleading. These averages include everyone in the retiree pool—even those who retired long before legislators played pension-hiking Bingo, or worked only part time, or left the system after a short stint. Meanwhile, the average private pensioner receives about $8,600 a year.
The formulas to assess pension payouts are a key source of fiscal instability, and tell a clearer story than lump-sum averages. In California, highway patrol officers are guaranteed 3 percent at 50—meaning they can retire at age 50 with 3 percent of their last years' pay times the number of years worked. So an officer who started at 20 can retire at 50 with 90 percent of her final pay, plus "enhancements." And an officer who has worked at least 20 years and retired in the last few years receives an average pension northward of $98,000.
"Miscellaneous" workers receive less generous pensions, but they still often can retire in their mid-50s with 80 percent of their final, oftentimes spiked pay. The state uses 99 categories of special pay that can add to a public employee's salary. For instance, librarians get special bonuses for helping patrons find books, and employees get salary spikes for filling in for their bosses when they are away. The CalPERS board decided last summer that those categories can be used to inflate the final pension payout even for new hires—effectively undermining a main part of the only serious pension reform California has passed. (That was the Public Employees' Pension Reform Act of 2013, which slightly reduced pension formulas for new hires, restricted pension spiking, and included a few more reforms designed mainly to grease the skids for passage of a tax-increasing initiative.)
The $200,000 Lifeguard
This isn't just unfair, it's expensive. The number of public sector employees receiving pensions of more than $100,000 a year in California is growing exponentially. The last 15 years have seen massive increases in the benefits bestowed by legislators and councilmembers. What's worse, most of these boosts were retroactive, going back to the day new retirees started working. Try even imagining that in the private sector.
News reports have highlighted many absurdities—city managers making $500,000 a year, lifeguards who earn packages worth $200,000. These often are depicted as aberrations, but such "aberrations" add up. The median compensation package for a firefighter in California is $175,000. In bankrupt San Bernardino, a typical firefighter earns 10 times the city's per-capita income. The city's salary schedule is littered with $200,000-plus employees.
It's not just the young, destined to bankroll these generous pensions for decades to come, who are getting screwed. Maintaining astronomical pay and benefit levels has required cities and states to cut back on present-day services. In formerly bankrupt (and still fiscally troubled) Vallejo, California, officials chose to shut down community centers and reduce police staffing rather than shave off even a small sliver of the benefits to current employees and retirees.
The poorest cities have felt the most impact, but public sector union greed has harmed wealthy ones, too. Former San Jose Mayor Chuck Reed makes a progressive case for reform. Pension costs have increased 350 percent over a decade in that city, in the heart of Silicon Valley. Reed argues that pension-grabbing corrupts the concept of public service and threatens the quality of life for future generations.
Reed's 2012 pension reform initiative received 70 percent of the vote in his heavily Democratic city, but it was then gutted in a court case. The courts have established a de facto California Rule—once a pension is approved it cannot be shaved, even on a go-forward basis.
The initiative would have increased employee contributions to help pay for their pensions—something the city thought it could do (despite the California Rule) because of provisions in the city charter. Some city unions challenged the measure and a Santa Clara County judge agreed the city cannot impose these costs on existing workers. The city was allowed to reduce pay—but the pension issue was the heart of the reform.
So short of bankruptcy, cities can do almost nothing about pensions other than cut services and/or raise taxes. Every municipal tax hike is functionally an exercise in paying for pensions, given the reality that money is fungible and pensions nationwide are dramatically underfunded.
The numbers can get absurd. As the Manhattan Institute's Nicole Gelinas explained in the New York Post in 2013, "New York pays more police in retirement than to patrol our streets." The same goes for Chicago and some other cities. "Eventually retirees will outnumber active workers by a ratio of nearly 2 to 1 in some CalPERS plans," The Sacramento Bee reported in November. Reed joked to Vanity Fair that eventually his city will be left with one worker: the guy who sends out pension checks.
'Math, Not Politics'
Union-controlled pension funds love to berate Wall Street, yet they are increasingly dependent on Wall Street returns to paper over their crazy projections. When California passed a bill that in 1999 triggered a pension-boosting bonanza, CalPERS predicted investment returns that "implicitly required the Dow Jones to reach roughly 25,000 by 2009 and 28,000,000 by 2099," said David Crane in 2009 testimony to the Senate.
Rhode Island's Democratic pension-reforming governor, Gina Raimondo, has a tart response to pension apologists: "This is math, not politics." Raimondo was a financier with little political experience when she ran for treasurer in 2010, the Washington Post editorial board explained in a September profile. She championed a bill that reduced pensions, making the same "progressive" case (without reform, services will be slashed) as Reed and other Democrats.
Her state's math was obvious, per the Post: "In Rhode Island's case, pensions for the state's 21,000 retired public employees were soaking up 10 cents of every dollar of state tax revenue; that would have risen to 20 cents in just a few years. The state's pension fund, already underfunded by some $7 billion, was spending more than it took in; it would have been completely broke in 25 years or less."
Here's the latest math for the rest of the country, from Bloomberg: "The 25 largest U.S. public pensions face about $2 trillion in unfunded liabilities, showing that investment returns can't keep up with ballooning obligations, according to Moody's Investors Service. The 25 biggest systems by assets averaged a 7.45 percent return from 2004 to 2013, close to the expected 7.65 percent rate. Yet the New York-based credit rater's calculation of liabilities tripled in the eight years through 2012."
So even when pension funds have recently come close to meeting their unreasonably optimistic predictions, their shortfalls are still growing, because the promises are too high and the contributions from employees too low.
For now, the unions can keep gloating about their political and legal victories. But eventually young people will get wise to the nature of this generational theft. If that happens, wealthy retirees better hope these younger folks have more compassion for them than the retirees have had for the rest of us.