Lessons from Well-Funded Public Pensions

[GregLee]

... has gone for option D. kick the can down the road, and now we have almost run out of road.

What's wrong with kicking the can down the road? "We have almost run out of road" -- that has a nice ring to it, but what does it actually mean? There will be no future generations?

 

[kyounge1956]

I didn't mean to imply there was anything wrong with this. I think it is actually a good thing most that state/local employes pay into SS like Federal employees. However when people on this forum talk about saving rates for retirement nobody includes the 12.4% combined employee/employer payments into SS so it is a far comparison.

point taken.

Actually comparing your payments from social security check to your pension payments is a useful exercise. Now since SS also funds disability payments, and survivors, and the payments favor poorer people, it isn't exactly comparable to a pension plan. On other hand the bulk of SS money goes to fund retirement payments and it isn't in great financial shape either. So if the contributions to the pension plan is 16% vs 12.4% for SS, than logically your pensions should be larger at given age say 62 certainly 1/3 larger at perhaps 50% bigger. My guess is that your pension is probably twice as big as your SS check.

I am planning to retire at age 57. If I stop working at age 57, the pension I'm eligible for immediately is over twice as much as the SS benefit I'm eligible for at 62, but not twice as much as the SS I would receive at my full retirement age of 66+4 months. However the SS benefit is fully COLA'd, while the pension has a partial COLA, a fixed percentage increase per year but guaranteed not to fall below 65% of its original purchasing power, based on CPI. At historic rates of inflation it would take 23 years to hit the 65% "floor" as it's called, and I expect to be retired longer than that. Also, if I understand it correctly, my initial SS benefit will change between when I retire and when I start drawing checks, according to changes in the cost of living during that time. So I think that early in my retirement, the pension will be larger in terms of buying power, but depending on when I actually start drawing SS and on the rate of inflation, SS will eventually gain on and possibly even pass the pension. I can't even begin to guess how to make a valid comparison between the pension and SS.

 

[kyounge1956]

I can see how that is possible. What I don't see is how it can be avoided by putting more money into the pension fund previously. Wouldn't that just precipitate the fiscal crisis at an earlier time?

Some pension funds took a "contribution holiday" during the bull market of the late 20th century. If they had put in the money they were supposed to put in then, they wouldn't be underfunded now, or at least not to the extent that they are. So for those systems, no, it wouldn't have precipitated a financial crisis at an earlier time. It might have made it impossible to grant a tax reduction or increased funding to some other area of government—whatever was done with the money instead of putting it into the retirement system. Even with a system that has been paying all contributions as promised, I think an increase in contribution levels in the past would be less likely to precipitate an economic crisis than having to come up with the money to meet large and ongoing shortfalls in the future. Compare it to your personal finances. What's more likely to cause an economic crisis in your household, having ten or fifteen years to save up for a new car, or having to come up with the cash to buy one on short notice, during an economic downturn when your wages have been frozen or cut?

The premise of this discussion about the soundness of pension funds seems to be that income from the fund is somehow free, while other moneys the state may use to pay pensioners are costly. I don't get that.

I don't understand what you mean by an assumption that the income from the fund is free. I think it is more a feeling—by employees, that we were promised a certain level of pension benefits, and by taxpayers that there has been an implied promise that employee pensions would be fully funded by the contribution rates built into the pension plan. If the pension plan then asks for more money, the taxpayers are understandably upset—they thought they had already paid for the pensions with their past taxes.

IMO, if pension fund trustees or public officials play "fiscal games", as you called it, they are failing in their responsibilities to both the employees (by risking that there will not be enough money to pay the promised pension benefits when they retire) and the taxpayers (by mismanaging what the taxpayers have already paid for this purpose and which, in a soundly designed pension plan, would have been enough to pay the promised benefits without increasing taxes later on). But I think there have also been a lot of unexamined assumptions in the past that are now being pulled out into the light, and people don't like what they are seeing. As an employee, I never gave a thought to whether the pension system was adequately funded, until it wasn't. And as a taxpayer, it never occurred to me that officials might be making promises about future benefits, without allocating the funds to fulfill them.

 

[clifp]

What's wrong with kicking the can down the road? "We have almost run out of road" -- that has a nice ring to it, but what does it actually mean? There will be no future generations?

Cause research done by these guy at Northwestern and other like the Pew Center for states, show state with badly funded plans like a Hawaii funds running out of money between 2018 and 2022. In the case of Hawaii this will require a 75% cut in current retire benefits.

I'll tell you if Hawaii jacks up my taxes by huge amount to pay in 5 or 6 year for the state employ pensions. I am moving. If on the other hand people start addressing the issue now that would be better.

 

[kyounge1956]

What's wrong with kicking the can down the road? "We have almost run out of road" -- that has a nice ring to it, but what does it actually mean? There will be no future generations?

In the case of the pension system I'm a member of, it means that the fund lost about 27% in the 2008 crash and (as of the end of the first quarter) still has about 10% less total assets than it did three years ago. It means the City workforce is largely made up of of baby boomers who will be retiring over the next decade or so, which will mean a big increase in what the pension fund has to pay out in benefits. It means even with the upcoming increase in contribution levels, there will be significantly less going into the fund than the actuaries say is needed to get back to 100% funding within 30 years, and that's with a perhaps overly optimistic assumed annual return of 8% (less 0.25% expenses). It means with 20% of total payroll (10% each employer & employee) going into the retirement system starting next year, there is not much room to increase the contribution rate further, and IMO certainly not higher than the actuaries' recommendation of (IIRC) about 26%. It means that even without having to pay for a pension fund shortfall, the City is facing multi-million dollar budget gaps the rest of this year, possibly next year, and who knows how many years after that. It means the slow economic recovery may result in a permanent reduction in the numbers of City employees, meaning less employee contributions and less employer match coming into the fund in the future. It means interest rates are at historic lows, so the fund doesn't really have the option of shifting to a more conservative allocation so it won't be hit so hard in any future market crash, because unless bond rates come up, it will certainly not make the 8% return needed to reach full funding if it does.

That's less money coming in, more money going out, what's looking like it may be a long period of economic doldrums, and no room to dodge a future market downturn. "Running out of road" means reaching the point where the only options will be a benefit cut, a tax increase, or both.

 

[GregLee]

"Running out of road" means reaching the point where the only options will be a benefit cut, a tax increase, or both.

But why are those the only options? The road down which the can is kicked is borrowing against future revenue, isn't it? So you must mean that it will become impossible to borrow against it. I just don't understand why you think that. Do you think there will be no future revenue?

 

[GregLee]

I'll tell you if Hawaii jacks up my taxes by huge amount to pay in 5 or 6 year for the state employ pensions. I am moving.

So Hawaii's problem is that if it raises taxes to pay state pensions, you'll leave. Do I have that straight? Personally, I would hate to see you go, but this doesn't seem to be a systematic problem for the whole state.

 

[kyounge1956]

"Running out of road" means reaching the point where the only options will be a benefit cut, a tax increase, or both.

But why are those the only options? The road down which the can is kicked is borrowing against future revenue, isn't it? So you must mean that it will become impossible to borrow against it. I just don't understand why you think that. Do you think there will be no future revenue?

I think future revenue and the ability to borrow against it are both finite. I would expect that, if a government goes too far into debt, its bond rating goes down, which means it has to pay higher interest on later bonds. At some point it would become impracticable, if not absolutely impossible, for it to borrow any more.

You seem to be implying it would always be possible for a local or state government to borrow as much as it needs to meet any possible pension shortfall, without decreasing its other expenditures nor raising taxes either now or in the future—that the day would never come where there were no other alternatives than to raise taxes or cut benefits—that the can could always be kicked without ever reaching the end of the road. Am I mistaking your meaning?

 

[GregLee]

I would expect that, if a government goes too far into debt, its bond rating goes down, which means it has to pay higher interest on later bonds.

Now, I think we are approaching clarity. Running out of road means the state's bond rating is going down?

You seem to be implying ... that the can could always be kicked without ever reaching the end of the road. Am I mistaking your meaning?

No, that's what I was implying.

 

[kyounge1956]

Now, I think we are approaching clarity. Running out of road means the state's bond rating is going down?(snip)

No, I think it means we disagree about a fundamental assumption. You think there will always be more road to kick the can down. I don't. It's possible for an individual to get so deeply mired in debt that they are unable either to meet their obligations or to borrow more. I don't see why it wouldn't be possible for a government to have the same problem.

 

[ERD50]

But why are those the only options? The road down which the can is kicked is borrowing against future revenue, isn't it? So you must mean that it will become impossible to borrow against it. I just don't understand why you think that. Do you think there will be no future revenue?

No, I think it means we disagree about a fundamental assumption. You think there will always be more road to kick the can down. I don't. It's possible for an individual to get so deeply mired in debt that they are unable either to meet their obligations or to borrow more. I don't see why it wouldn't be possible for a government to have the same problem.

I agree with kyounge1956 here. IIRC, GregLee was saying much the same thing in another thread a few months back, or at least questioning the 'conventional wisdom' that there is a limit to the amount a govt can borrow. I think it was GoneForGood who posted some background on borrowing limits (% of GDP, revenue in/out?) - at some point the revenue just can't support the debt. But I don't recall if there was enough follow up to conclude what that point was.

Originally Posted by clifp
I'll tell you if Hawaii jacks up my taxes by huge amount to pay in 5 or 6 year for the state employ pensions. I am moving.

So Hawaii's problem is that if it raises taxes to pay state pensions, you'll leave. Do I have that straight? Personally, I would hate to see you go, but this doesn't seem to be a systematic problem for the whole state.

Actually, it is a systemic problem. IL for example, raised corporate tax rates, and several large corps threatened to leave if they didn't get a tax break (and they got it). Now, smaller corps don't have enough weight to throw around to demand a tax break - but you can bet that they are thinking of leaving, or if they are expanding, will look for options over the border in more business-friendly states. Indiana, Wisconsin, and even New Jersey have been actively seeking IL businesses. I think you can fine examples of this in other states as well, but you don't really need data to predict this, it's simple supply/demand.

-ERD50

 

[GregLee]

Indiana, Wisconsin, and even New Jersey have been actively seeking IL businesses.

So which businesses, I wonder, would relocate to Indiana if Hawaii dares to raise tax rates ... Bound to be some, since it's just simple supply/demand.

 

[ERD50]

So which businesses, I wonder, would relocate to Indiana if Hawaii dares to raise tax rates ... Bound to be some, since it's just simple supply/demand.

It's all a matter of degrees. Every business has decisions to make when it is time to expand (or maybe consider moving current facilities offshore). A big part of that decision will be just how 'business friendly' the area is. There is bound to be a consequence to raising taxes. It might not be a headline, like 'mega-corp moves 1500 jobs to Indiana' - it is more likely decisions made in board room that never hit the news. If they open the new office in Indiana rather than HI, the news won't be that HI 'lost' jobs, but in fact they didn't share in the growth. But the overall effect will be that the business friendly areas will tend to get more jobs over time. Is there really any doubt of that?

Heck, you can see it right on this forum - how many threads have there been discussing which are the most tax-friendly states for retirees? It's not the only consideration, but it is a consideration.

-ERD50

 

[ziggy29]

So which businesses, I wonder, would relocate to Indiana if Hawaii dares to raise tax rates ... Bound to be some, since it's just simple supply/demand.

It's not always relocation of existing businesses. It could also be business that decide to expand out of state, or new businesses deciding to form elsewhere. The net effect, though, is roughly the same.

I'm not a fan of big corporations demanding tax breaks that their smaller competitors can't get (that's a type of favoritism/crony capitalism that should be outlawed IMO), but in terms of fair and consistent tax policies that apply to *all* people and businesses, the "states as 50 laboratories" approach is always instructive as you can clearly watch the cause and effect unfold.