Using a credit card: A 'how not to' guide from the debate over public pensions
06/18/2014 10:07AM ● Published by ACL
By Stephen Herzenberg
There is a reason the payday loan industry is so successful. It preys on vulnerable families with the promise of fast cash now to take care of pressing needs. The catch is, as with any debt, the bills will always come due.
This is the fundamental problem with Governor Corbett’s current state pension proposal. It preys on a legislature desperate to take care of a pressing need – a $1 billion budget shortfall of its own making. To help address this shortfall, the governor wants to “reduce the pension collars.” In plain English, this would allow the state to lower its legally required payments into the pension system.
But lowering this year’s pension payments is like putting more debt on the state credit card. The bill will always come due.
The Corbett plan is tied to a proposed pension overhaul from Rep. Mike Tobash – a so called “hybrid proposal” that is being sold as a cost-saver for the state and school districts. The Corbett-Tobash proposal provides no savings in the current budget cycle. Further, it would cut benefits for Pennsylvania’s teachers, public health nurses, and food service workers by 40 percent or more.
Here’s how the Corbett-Tobash “hybrid” pension proposal works: employees get a small guaranteed pension on the first $50,000 of salary – a maximum benefit of $25,000 annually. Salary above $50,000 (and government service beyond 25 years) would be covered by 401(k)-type savings accounts, which have left millions of retired private workers economically insecure. In the long-term, thanks to inflation, the Corbett- Tobash guaranteed pension disappears, leaving only the 401(k)-type account.
Even before you get to the hidden costs of the Corbett-Tobash plan, its savings are overstated. Supporters suggest that the plan will save anywhere from $11 to $16 billion, but most savings come 15 or 25 years from now. But a dollar saved down the road is not worth as much: unlike a dollar in hand today, it does not earn interest starting day one. In today’s dollars, the Corbett-Tobash plan saves a maximum of about $4 billion. In fact, even Governor Corbett has said that his plan doesn’t save that much money.
Now for those hidden costs.
First, 401(k)-type retirement plans deliver low investment returns and impose high fees for administration, financial management, and buying annuities. At best, they deliver about two thirds as big a pension check for the same level of contributions to traditional pooled pensions. All the pension experts who have studied the Corbett-Tobash plan acknowledge that the 401(k)-type savings deliver less bang for the buck.
Second, moving from a traditional pension plan to a 401(K)-style plan results in high “transition” costs. Last year, when Governor Corbett proposed closing the traditional pension systems completely and moving new employees entirely into a 401(K)-style plan, experts estimated that the transition would cost $40 billion. Even a much lower transition cost for the current hybrid proposal could wipe out any savings.
Lastly, the Corbett-Tobash plan will require increasing public employees’ wages in the future. Why? Because cuts to pensions weaken the incentive for employees to stay in public service until retirement. Without wage hikes, many teachers and other public servants will leave for private-sector jobs that pay more. Even before pension cuts, Pennsylvania public sector workers with college degrees earn far lessthan similarly educated private employees.
Remember, Pennsylvania pension benefits were already slashed deeply in 2010. The average public employee only earns a $25,000 pension per year. With Corbett-Tobash cuts, Pennsylvania retirement benefits would be among the lowest in the nation.
Instead of adopting the flawed Corbett-Tobash plan, Pennsylvania lawmakers need to address, not exacerbate, the root cause of Pennsylvania’s pension debt – low employer funding. They can start by recapturing some of the more than $3 billion Pennsylvania loses annually because of expensive corporate tax subsides that do little to boost job creation. Asking corporations to pay their fair share would not only allow us to put our pensions on the path to full funding, but also blunt Governor Corbett’s draconian cuts to education and other vital services.
Stephen Herzenberg, PhD, is an economist and the Executive Director of the Keystone Research Center.