In addition to collecting a pension, most public employees also participate in Social Security. A few states, such as Maine, never integrated with the program, which means their public sector workers don’t collect Social Security, nor are they subject to the 6.2% payroll tax.

Mary Williams Walsh reports that in an effort to solve their pension underfunding Maine is considering changing its Social Security holdout status. Maine’s state employees would begin paying into and collecting Social Security without having contributed to the system over their working lives. While reducing Maine’s risk of paying for large losses, the move doesn’t address the $4.1 billion hole in Maine’s pension plan (a hole already underestimated since assumes a 7.75% return on assets). And there is the instability of the Social Security program which is projected to begin running a deficit in 2017.

However, integrating with Social Security could be part of a transition to an improved state retirement system. Joshua Rauh explains at the New York Times‘ Room for Debate how the federal government might step in to head off the state pension crisis.

In the Wall Street Journal, John Fund reports on the Aspen Ideas Festival, a large gathering of innovators and creative policy thinkers. Discussing education reform, he points out that Bill Gates seems to agree with Eileen and Veronique on the problems of fiscal illusion.

Mr. Gates said a big part of the problem [with education spending] is “fraudulent” state budgeting systems, which fail accurately to account for the cost of pension promises. A legislator who “says ‘yes’ doesn’t feel any pain at all,” he said. Thus the “accounting fraud” that lets politicians treat generous teacher pensions as a free lunch rewards them for spending more on retired teachers than on current students.

As Eileen and co-author Andrew Biggs put it:

Given the costs and risks inherent in the defined benefit plan to taxpayers, as well as the political incentives for legislators to over promise benefits to public sector workers while shirking on the state’s contributions, the state should close the current defined benefit plan to new workers and expand the existing defined contribution plans for all new state and local workers. Shifting employees to a defined contribution plan would ensure that New Jersey’s pension system for its public sector workforce is sustainable in the long term and reward younger workers with a guaranteed employer contribution to their individual retirement.

As Mr. Gates is well aware, this problem isn’t some Sopranos-state anomaly, it’s common practice at all levels of American governance. If we want to move forward on fixing our institutions, we have to get an accurate picture of how badly they’re being mismanaged, and eliminate those harmful practices. Students, parents, teachers, and taxpayers are all in this together.

Eileen is the guest on this week’s Inside State and Local Policy Podcast, with your host Jim Musser. She discussed her new paper with Andrew Biggs from the American Enterprise Institute. You can listen here. She was also on Fox Business earlier this week, which you can see here.

Ezra Klein conjured up a fanciful reason why the stimulus spending hasn’t stimulated… anything. Matt and Eileen broke it down pretty thoroughly. Today, Mercatus Senior Research Fellow Veronique de Rugy has some visual evidence to rebut Ezra’s Keynsian dreams.

Klein is exactly wrong when he writes:

Uncertain about the future, [consumers] spend less now. The role of the government is to step up and keep the economy moving until consumer confidence returns.

Uncertainty isn’t a side-effect of a downturn, it’s a primary cause. In the recent bust, asset values were drastically skewed. If the government “keep[s] the economy moving,” confidence can’t ever return; everyone knows the old status quo was horribly flawed. Ezra, like Krugman, believes that government spending can drive an economy. Veronique’s chart neatly dispels the illusion that public spending can effectively supplement (or supplant) the private sector.

Eileen Norcross and Andrew Biggs have a new paper out this morning entitled “The Crisis in Public Sector Pension Plans: A Blueprint for Reform in New Jersey.” While it’s focused on New Jersey, it does an excellent job of outlining the larger problem with state pension plans nationwide and what policy makers can do about it.

Here’s the abstract:

New Jersey’s defined benefit pension systems are underfunded by more than $170 billion, an amount equivalent to 44 percent of gross state product (GSP) and 328 percent of the state’s explicit government debt. Depending on market conditions, the state will begin to run out of money to pay benefits between 2013 and 2019. The state’s five defined benefit pension plans cover over 770,000 workers, and more than a quarter million retirees depend on state pensions paying out almost $6 billion per year in benefits. Nationwide, state pensions are underfunded by between $2.8 trillion and $5.2 trillion, some 20 to 37 percent of America’s annual output as much as $3 trillion, approximately 20 percent of America’s annual output..

This path is not sustainable. In order to avert a fiscal crisis and ensure that future state employees have dependable retirement savings, New Jersey should follow the lead of the federal government and the private sector and move from defined benefit pensions to defined contribution pensions. While significant liabilities will remain, the first step to addressing the pension crisis is capping existing liabilities and providing new employees with more sustainable retirement options.

Specifically, the paper recommends that policy makers:

• Extend the defined contribution plan already available to state university faculty and staff and the state’s Defined Contribution Retirement Program to all state employees.
• Reduce or freeze cost of living adjustments (COLAs) to reduce the state’s unfunded liability.
• Transition non-vested workers to defined contribution plans.

Whole thing here.

The Market Ticker advises Illinois residents to “Move. Now.”

According to documents obtained by Medill News Service, Illinois pension plans invested in derivatives to make up for market losses. The Illinois Teachers’ Retirement System (TRS) has the fourth riskiest balance sheet of all pension plans in the country, with 81.5 percent of its investments classified as risky.

As with most state pension plans, the TRS assumed an 8 percent annual return on pension asset investments. With market performance down, plan managers have turned to higher risk/higher return “exotic investments” to make up the difference.

TRS is on the risky side of the Over-the-Counter Credit Default Swaps. TRS is selling and writing OTC derivatives thereby guaranteeing payment in the event of default to buyers.

The European debt crisis in turn guarantees that TRS is “going to bleed money.”

Illinois’ Day of Reckoning is imminent and they aren’t alone. Joshua Rauh calculates when other states can expect to run out of funds to pay pension benefits.

Via the Washington Examiner, yesterday two Fairfax County Supervisors suggested moving employees from a defined benefit pension to a 401(k) retirement plan.

“A dip in the stock market can cause an immediate and unexpected need for an employer — in our case the government — to increase their contribution to the retirement fund,” [Supervisor Pat] Herrity said. “We all know there are only two ways to pay for [retirement funding shortages]: cut something else in the budget or raise taxes.”

Allowing easier forecasting for retirement payments, defined-contribution plans such as 401(k)s have become more popular with employers and governments in recent years. Montgomery County employs such a system.

Dan, Eileen and I have written before on the problems with defined benefit systems, but it looks like some of our neighbors haven’t been paying attention.

“We’re not making the salaries we would be making in comparable private positions,” [Fairfax County Government Employees Union President Karen Conchar] said. ”You’d end up with a less motivated staff if you went to a defined-contribution-type plan. It would not be good.”

Ms. Conchar is flatly wrong on all three points. First, nationwide, public employees make significantly more than the private workers who provide for their retirement.

The only possible explanation for Mrs. Conchar’s claim would be specific to Fairfax County, which is one of the largest and wealthiest places in the country, and likely an outlier to national data. Even given that, it’s strange to complain about living in an uber-prosperous area.

Second, can anyone explicate the perverse incentives that would explain her “less motivated” remark? 401(k)s force employees to take a responsible and accountable role in providing for their own retirement, without the risk that unions or legislatures will use pension plan trust funds as political slush funds. When are people more motivated: when they have incentives to act responsibly and care about something, or when they’re given unconditional promises?

Lastly, it would be a good move, saving Fairfax taxpayers money, and providing a more secure retirement for public servants. Everybody wins.

In my recent op-ed on the structural flaws of public pension systems, I argued that politicians, union heads and bureaucrats use their positions to play taxpayers against public employees for political and financial gain. Monday, the New Jersey Star Ledger reported on a growing backlash against public employee benefits:

In internet postings and on talk-radio shows, government workers are being called “greedy” and “bloodsuckers.” Commenting on the teachers union, one writer called its members “the worst human beings on the face of the planet.” Criticizing the police, another wrote, “The typical criminal could never steal what these cops are walking out the front door with.”

As New Jersey’s unemployment hovers at 10 percent and 401(k)s are dented by stock-market losses, retired public workers find themselves on the receiving end of “pension envy.”

“I understand that I retired with a good pension and the taxpayer contributed to it,” said Tevlin, who kicked in 8.5 percent of his salary toward his pension, which is about $4,000 a month. In his mind it was a fair bargain: In exchange, the public received reliable emergency services. “I don’t apologize to anybody,” he said. “I did a dangerous job.”

This kind of infighting doesn’t serve anyone’s interests. It highlights the problem inherent in the defined-benefit pension system. Theoretically, public employees work for the taxpayers, providing public goods like public education, safety, and emergency services. In reality, taxpayers have little if any direct control over public employees. Those employees are hired by, paid by, and responsible to either public sector unions or directly to bureaucracies. Those middlemen finance their outfits with taxpayer money. Playing one group against the other is an easy way to remain in power.

A 2008 study by the Hudson Institute analyzed collectively negotiated (i.e. union) pension plans versus non-union plans. The results are staggering. These numbers encompass both public and private plans:

- Privately negotiated plans are 98% funded. Union plans are only at 88%.

- For large plans, 37% of non-union plans are fully funded, versus only 19% of union plans.

- For large plans, 2% of non-union plans are in critical financial situations, while 11% of union plans are in crisis mode.

In short, the Hudson study shows that union negotiated plans are significantly worse off than private plans. Similarly, Monday Barron’s reported that the public pension crisis is far worse than the Pew Center study I referenced:

More debt defaults and bankruptcy filings probably lie ahead, unsettling the $2.7 trillion municipal-bond market. The possibility of taxpayer revolts and likely insolvencies has shaken some investors’ confidence in general-obligation bonds — those backed by the “full faith and credit” of the states or localities. Once the gold standard for munis, GOs are under a cloud in financially troubled areas.

The size of the legacy-pension hole is a matter of debate. The Pew report puts it at $452 billion. But the survey captured only about 85% of the universe and relied mostly on midyear 2008 numbers, missing much of the impact of the vicious bear market of 2008 and early 2009. That lopped about $1 trillion from public pension-fund asset values, driving down their total holdings to around $2.7 trillion.

When you can promise public employees lucrative salaries and benefits, while paying for it all with someone else’s money, it’s easy to imagine running up such a ludicrous tab.

No one, of course, would dispute that public servants deserve adequate retirements, particularly the 25% to 30% that lack Social Security coverage. But the old saw that rich retirement packages are a necessary inducement to attract good employees to public payrolls because of below-average pay scales no longer is true.

According to the latest compensation survey by the Bureau of Labor Statistics, the average state and local employee outearns his counterpart in the private economy with an hourly wage of $26.11, versus $19.41. That’s before benefits (pensions, health care, paid vacations and sick days and leaves) drive the disparity even higher, to $39.60 an hour for public employees and $27.42 for private workers.

In public pensions, we allow politicians to play us against real servants of public health and safety. The system needs to change.

Is there any other kind? I have an op-ed up at AOL News on the looming crisis in state pension funds. The New York Times article I reference is here, and the Pew study is here.

If you’d like to read more on this coming pension tsunami, we recommend this. Eileen and I have forthcoming issue of Mercatus on Policy on the issue, and will have a longer paper in the future.

According to the New York Comptroller’s Office, by 2015 New York’s county pension costs are set to soar from $2.6 billion to $8 billion – amounting to nearly one-third of civilian payroll costs (and 40 percent of fire and police payrolls). Recovery depends heavily on the stock market’s performance. And, even if the market does recover, tax hikes and/or benefit cuts are likely inevitable.

The public sector pension crisis is much vaster than New York; many states and local governments have spent years overpromising benefits, deferring contributions, and underestimating the size of those unfunded liabilities. Public sector pension plans are underfunded nationally by $310 billion.

Governor Paterson and Comptroller Thomas diNapoli disagree over how to deal with New York’s mounting pension system losses.

The comptroller suggests local governments increase their contributions, a strategy the governor argues will only raise property taxes. Governor Paterson suggests limiting benefits to new employees.

At least the state isn’t taking Montana’s approach to its pension crisis: when your actuary tells you to cut benefits or increase contributions, hire another actuary.

The New York Times notes the root cause of the nationwide crisis in public sector pension plans: the difficulty of saying “no” to unions:

If there is any silver lining, the trends appear to have somewhat curbed Albany’s appetite for extending pension enhancements to public employees to placate labor unions, which wield enormous clout and lobbying dollars in the capital.

“I’m alarmed,” said Assemblyman Peter J. Abbate Jr., a Brooklyn Democrat and the chairman of the Assembly’s Labor Committee, who is one of the capitol’s more reliable union allies.

“Bluntly,” he said, “I’ve spoken to a lot of the union leaders and their lobbyists and said I don’t want to see bills that will cost the counties and the state millions of dollars.”

Andrew Biggs of the American Enterprise Institute discusses how governments cook their public pension books in the Wall Street Journal.

The Financial Times writes:

The 2,600 [American state and local government] pension plans provide retirement savings for 22m public employees in towns and cities across the US, and range in size from the giant Calpers, with $120bn (€91bn, £81bn) in assets, to tiny small town funds which pay pensions for local garbage collectors and police.

[...]

State pension benefits are protected by law, and must be paid even if the fund is making a loss. Calpers, the largest fund, has lost $70bn in value in the past eight months, but still has to pay $11bn in benefits this year. Unless the fund starts recouping its losses soon, the California state government, which is already mired in a huge deficit, will have to lift contributions to Calpers starting from next year.

The FT goes on to note that US pension plans are in worse shape than those in Europe.

This is because American pension funds are more underfunded. That gets back to policy decisions made over the years. Couple that with the worst economic downturn in decades, and policy makers are left with tough choices: cut benefits, increase the size of contributions, or merge plans.

Places with pension funds that are less than 50 percent funded include Philadelphia, West Virginia, Pittsburg, Providence, Little Rock, Jersey City, Wilmington, Deleware, and Atlanta.