Scott Beaulier of Troy University and a Mercatus Affiliate Scholar has a study analyzing how states might make the transition from defined benefit pension plans to defined contribution. He cites the success stories of Michigan and Utah, two states that have moved toward defined contribution plans and have each saved billions in the process.
Both papers reach the conclusion that public officials should not be in the business of managing defined benefit pension funds because they do not have the correct incentives to steward these benefits. Politicians operate in the time frame of election cycles. They have an incentive to provide future benefits without raising taxes in the short-run and are thus in a poor position to be in the business of the long-term management of pension benefits.
We held a State Policy Working Group at Mercatus today to discuss these and other recent pension studies. If you would like to attend or call in to future working groups, please email firstname.lastname@example.org.
The motivating question is this: why are rising costs for public worker benefits such a surprise to so many state and local governments? In addition to the core problem facing all plans: the misvaluation of pension liabilities based on flawed discount rate assumptions (and the practice of asset smoothing), there are things unique to individual state and local governments. In the case of New Jersey, pension policy is set by the state government, as are the accounting guidelines used by local governments (They do not use GAAP). This had led to a tangle of accounting assumptions that have had the effect of (temporarily) lowering the annual bill. Costs were pushed forward to become a policy problem for today.
While these municipalities report the total cost for public employee compensation as requiring about half of their budgets, when fully accounting for costs, public employee compensation including unfunded liabilities for earned benefits rises to about 86 percent of these budgets. This is an unpleasant surprise in a state with high property taxes and it is certain to make budgeting more challenging in the coming years for both the state and its many municipal governments.
Unfortunately, New Jersey’s pension system is in seriously bad shape and slated to run out of assets to pay out pension promises by the end of the decade. The reasons for this have been discussed many times before. First, is the fundamental misvaluation of pension liabilities, the systematic under-contribution that flows from that and policy choices such as pension holidays, skipped payments and benefit enhancements. To fund pensions according to Joshua Rauh, New Jersey would require the largest per household increase in contributions at $2,475 per household, per year.
In a new paper to be posted soon, my co-author Roman Hardgrave and I take a deeper look at New Jersey’s public employee benefit bill on a local basis. When fully accounting for pension promises, OPEB and other benefits the cost of compensation on the local level is far greater than is recognized.
In the case of Colorado and Minnesota the unions’ suit was thrown out on the grounds that there is no specific right to the COLA. How will the NJ court decide on formula changes and the COLA freeze? Interestingly, a N.J. Superior Court judge has also filed a lawsuit against the state. He says the new law should not apply to judges since the N.J. Constitution says judges’ pay, “shall not be diminished during their term of appointment.”