Tag Archives: public sector workers

The political economy of state and local public pensions

Edward Glaeser of Harvard and Giacomo Ponzetto of Centre de Recerca en Economia Internacional have a new paper on fiscal illusion in state and local public pensions (and they don’t cite James Buchanan?!):

Why are public-sector workers so heavily compensated with pensions and other non-pecuniary benefits? In this paper, we present a political economy model of shrouded compensation in which politicians compete for taxpayers’ and public employees’ votes by promising compensation packages, but some voters cannot evaluate every aspect of compensation. If pension packages are “shrouded,” meaning that public-sector workers better understand their value than ordinary taxpayers, then compensation will be inefficiently back-loaded. In equilibrium, the welfare of public-sector workers could be improved, holding total public sector costs constant, if they received higher wages and lower pensions. Central control over dispersed municipal pensions has two offsetting effects on pension generosity: more state-level media attention helps taxpayers better understand pension costs, which reduces pension generosity; but a larger share of public sector workers will live within the jurisdiction, which increases pension generosity. We discuss pension arrangements in two decentralized states (California and Pennsylvania) and two centralized states (Massachusetts and Ohio) and find that in these cases, centralization appears to have modestly reduced pension arrangements; but, as the model suggests, this finding is unlikely to be universal.

Gated versions here and here.

Discount rates and pension plans: 98 percent of economists agree….

I realize that 98 percent sounds impossibly unified around any subject. But I find this recent survey by the University of Chicago’s IGM Economics Experts panel especially compelling. According to their survey of 39 professional economists, 98 percent agree that public sector plans understate pension liabilities and costs by using high discount rates.

Here’s the question as stated:

Question A: By discounting pension liabilities at high interest rates under government accounting standards, many U.S. state and local governments understate their pension liabilities and the costs of providing pensions to public-sector workers.

The response:

49 percent strongly agree

49 percent agree

Who was surveyed?

39 economists – from across the field –  including Richard Thaler (Chicago), Jose Scheinkman (Princeton), Robert Hall (Stanford), Austen Goolsbee (Chicago, and former advisor to President Obama), Barry Eichengreen (Berkeley), Claudia Goldin (Harvard), Alberto Alesina (Harvard) and Daron Acemoglu (MIT).

You can check out who was surveyed and their academic credentials at the site.

This principle concerning the valuation of pension liabilities is not very controversial (or even interesting) for economists as M. Barton Waring has noted in, Pension Finance. It only remains controversial among actuaries and policymakers/pension plan analysts and advisors in this one corner of the world: U.S. public sector pension plans. It is partly a matter of professional training. Economists and actuaries are using different toolkits to evaluate plans. (There are notable exceptions, see, Gold and Bader). It is also a matter of the implications of what happens when governments use discount rates more in line with the guaranteed nature of public plans. Lowering discount rates increases the necessary contribution.

But if governments are serious about offering these plans as guaranteed to retirees, then they should be especially interested in valuing them accurately.



Central Falls Receiver: Bankruptcy can be a good thing

Central Falls, Rhode Island receiver Robert Flanders addressed the Rhode Island Statewide Coalition this weekend and took the opportunity to praise the process of bankruptcy for municipalities in deep distress. Reports The Pawtucket Times, “It’s not a horrible thing, it’s a thing we ought to be doing,” From his view bankruptcy allows a municipal government to make the necessary change to come back stronger. The stigma attached to bankruptcy he argues is short-lived. Another lesson offered: Rhode Islands small governments have built up expensive debts in the form of promises to public sector workers and it might be worth school districts and municipalities merging administrative expenses.

The core problem in cash-strapped, economically struggling Rhode Island towns is how to pay for the increasing costs for government without putting even more pressure on residents and businesses.

Richard Brodsky, who is currently on a board advising Yonkers, NY as the city tries to bridge a massive budget gap, writes at The Huffington Post, that the problems afflicting many municipal governments can be traced to budget gimmicks and attempts to “kick the can down the road,” noting that blame tends to be shifted to overly-generous employee pensions.

I tend to agree. Pension and health care costs are driving many (but not all) municipal fiscal crises. Years of misleading accounting gave all parties a false sense of fiscal security. This has led to benefit enhancements negotiated by unions and politicians, governments skipping payments, and excessive risk-taking with plan assets. There is plenty of blame to go around.

How to fix it? Begin with accurate numbers. Recently Mayors and executives from across New York State met in Albany to discuss the unforgiving and unavoidable math behind rising pension costs, with the Mayor of White Plains noting, “The road to hell is paved in amortizing pensions,”

Pension costs rising in local governments

Long Island villages are contending with increasing contributions to the state pension system. They expect to be billed $1.2 billion this fiscal year for school district employees, public workers, police and firefighters. Maryland counties can expect to begin footing part of the pension tab for teachers in a cost-sharing plan put forth by Governor O’Malley. And Rhode Island municipalities are asking the governor for increased state aid to fill their pension shortfalls and budget deficits.

What is worth noting in all of these cases is how this funding crisis highlights both the importance of accurate accounting, and the fiscal relationship between the state and local governments. Where localities participate in the state plan but do no make annual contributions (as in Maryland), there is a tendency for fiscal illusion to take over. The plans seem inexpensive and thus counties may end up expanding other parts of the county budget. Billing local governments for their portion of the pension tab makes for good fiscal discipline and transparency.

In the case of Long Island, the costs are already shared between the state and local governments. Rhode Island municipalities participate in the state run plan and in many cases operate their own local plans. Here the problem is the same as it is across the country – pension promises have been undervalued and thus underfunded. Costs are rising fast. State and local governments are going to be sharing in the growing burden in the form of higher taxes, service cuts and/or increased debt. Pension plans will be reformed and restructured. But the first step must be an accurate accounting as we found in our recent research on New Jersey.

In New Jersey pension costs are shared between the local and state governments. As with all plans the costs are obscured for the purposes of accounting leaving a good portion of the mounting expense off the books. Accounting choices that push costs forward or hide them altogether have turned pension funding into a looming nightmare for city governments, public sector workers and taxpayers across the country.

Collective bargaining and health care benefits in New Jersey

Is collective bargaining for public employees an “historic right”? That is the position of Bob Master, political director of  the Communication Workers of America (CWA), one of New Jersey’s public sector unions. He objects to a plan put forward by Governor Christie and Senate President Stephen Sweeney that would allow the legislature to set health care benefits, removing the item from the negotiating table. As for the historic nature of collective bargaining. Such powers arrived relatively recently in the public sector. With most states extending these provisions in the 1960s and 1970s, and up through the late 1980s. For a review, see my recent paper. (Economist Leo Troy, and political scientist Joseph Slater each provide a history of public sector unionism and reach the opposite conclusion on the implications of collective bargaining in the public sector.)

In New Jersey pension policy has always been a matter for legislation, a fact that Mr. Master does not challenge. Even if health benefits are removed from the table this does not eliminate the political leverage  public unions have over influencing legislators and thus legislation. Nor will it fix the core problem. Health benefits in New Jersey are completely unfunded and face a $66.7 billion liability.

Part of the reason that the bill has suddenly materialized is that until 2007 governments were not required to recognize the cost of Other Post Employment Benefits (OPEB) on their books. A bomb was dropped when this rule went into effect revealing $1.5 trillion in hidden liabilities in U.S. state and local governments.

Unlike pensions health benefits don’t come with the same guarantees. Of far greater relevance for public sector workers is how are state and local governments going to provide health benefits in the face of  such daunting costs? The Christie-Sweeney proposal asks workers to contribute on a sliding scale from 3 percent to 35 percent of their health insurance premiums depending on their salary.

Assembly Leader Sheila Oliver backs the unions’ position and proposes that health benefits remain off the table for three years. In 2014, collective bargaining for health benefits would be re-established and unions could seek lower contribution rates during the negotiation process. It would also make collective bargaining a gubernatorial campaign issue. It is a strategy that points to the uniquely political nature of public sector unionism. And it underscores the institutional incentives for politicians to promise short-term benefit enhancements at the expense of long-term solvency.


The Hutton Report

Last week, Lord Hutton of Furness released his long-anticipated report [pdf] recommending changes to the future of the British public employee pension systems. It contains some pretty stark recommendations, especially in comparison to most of what has been suggested in America.

For instance, while many American public pension reform proposals include changing the pension calculations to the final five years’ salary rather than the final three (to prevent so-called “pension spiking”), Lord Hutton’s recommendation is to calculate pensions based on average career pay. Additionally, he would greatly increase the retirement age in the uniformed services (police, firefighters, military) to 60 years, as much as a 10 year increase. Generally, public sector workers will expect about a five year increase in age of retirement.

Here is what the Hutton Report calls “The Deal,” which helpfully reminds us that what’s really at issue is negotiations between public sector employees and taxpayers.

Here’s a good summary of provisions by the FT. Here’s the Treasury FAQ.

Me on CNBC

I was on CNBC yesterday morning debating Professor Harley Shaiken on the Wisconsin situation. Here is the video:

Here is a link to Professor Shaiken’s website.

Here is a link to the GAO report I referenced. If you think the budget gaps of the last few years have been bad, you ain’t seen nothing yet: States face a $9.9 trillion shortfall over the next several decades.

In order to close these long-term gaps, the GAO estimates that states need to immediately cut 12.3 percent (or increase taxes by the same amount) and maintain these changes each and every year for the next 50 years. To put that in perspective, last year states cut 5.9 percent out of their General Funds (total spending, which includes borrowed funds, other state funds and federal funds actually increased!). So, as painful as the last few years have been, states are nowhere close to doing what they need to do in order to address their long-term problems. 

Professor Shaiken mentioned studies that find public-sector employee pay is comparable to private sector pay. Here is one such study. And here is another.

Here is Andrew Biggs and Jason Richwine from yesterday’s Wall Street Journal on why these studies are flawed. To wit: a) they typically don’t account for health benefits, b) they fail to accurately compare the value of guaranteed 8 percent returns in public pensions with 4 percent guaranteed returns in private 401(k)s, and c) they do not take account of greater job security among public sector workers. Here is a link to Biggs and Richwine’s analysis. Here is Veronique de Rugy on the matter. Here is Megan McArdle. Here is a New York Times graphic that focuses just on Wisconsin employees (counting only cash compensation, the median Wisconsin public employee–who is typically more-educated–earns 22 percent more than the median Wisconsin private employee).

Here is a paper that assesses the empirical link between public sector unionism and government spending.

Interns of the World, Unionize!, or The Costs and Benefits of Unions

Most economists—whether the they favor unions or not—view them as cartels. That is, unions are price-fixing organizations that collude to raise their price (aka the wage rate) above what would prevail in a competitive market. What could possibly be wrong with that?

Not much if you happen to be in the union. But there is quite a bit wrong with this if you happen to be a nonunion worker, jobless, a consumer of union-made products, or a taxpayer whose employees (public sector workers) are unionized.

Why is this so? Well think about the way a union works. When it negotiates to raise the wage above what would prevail in a competitive labor market, two things happen: 1) employers want to hire fewer employees at the new, higher wage, and 2) more people want to become employees at the new, higher wage. When this happens, those who don’t carry a union card are priced out of the market.

When I was in college, I had a LOT of internships (usually working for nonprofit research organizations). The going wage for an internship at the time was something like $1,000 a semester, or about $3.00 an hour if you worked 20 hours a week for 16 weeks. This was not enough to live off of and today I write a student loan check every month as a reminder. But I was willing to work for this paltry wage because I knew—given my low experience level—employers wouldn’t be willing to pay any more. I also knew I would learn new skills during the internships so that one day I could command a higher wage (even net of student loan repayments).

Now imagine what would have happened if, back in the late 1990s, all the interns had unionized and successfully bargained for higher wages. Research organizations would have decided that they could make do with fewer interns and a few more full-time students would have decided to apply for the internships. This combination would have inevitably locked some people—perhaps me—out of the opportunity to intern.   

Thus, nonunionized interns would have suffered. The customers of the research organizations would have also suffered as they would have seen a decrease in the quantity and quality of research that the organizations produced. Even those in nonunionized industries would have suffered as they would have found themselves competing with a higher supply of workers who couldn’t find internships. Arguably, there would have been longer-term costs as well because large sections of the workforce would have missed out on the opportunity to gain valuable on-the-job-training.

Unions likely benefit those who are in them. Research suggests that U.S. union workers’ wages are about 18 percent higher than those of nonunion workers (I say ‘likely benefit’ because despite this, many workers still prefer not to be part of a union). But whatever benefits do accrue to unionized workers, it is helpful to remember that there are also costs.

Public Sector Union Reform in the States

The New York Times features an article on how some states are looking to scale back the power public sector unions currently enjoy. Prompted by the scope of the fiscal impact that pensions and other benefits are having on state and local budgets, Governors and Legislators are considering taking away collective bargaining as well as potentially banning public sector workers from organizing. The head of the American Federation of State, County and Municipal Employees says these moves are  just payback for public sector unions’ financial support for particular candidates.

The late 20th century rise of the public sector union is one of the most profound and until recently, largely overlooked, changes that occured in American government. As Rutgers economist Leo Troy has noted the rise of public sector unionism represented a “structural break” from the Old (private sector and industrial) Unionism. However, many labor economists continued to treat the two as similar a major misstep in understanding the nature, goals, and implications of government unions.