Joshua Rauh of the Kellogg School of Management and Robert Novy-Marx of the Simon Graduate School of Business have a new paper out that looks at how much revenue states will need to be able to pay in full the pensions of local and state public employees over the next 30 years. The answer: a lot of money.
Without policy changes, contributions to these systems would have to immediately increase by a factor of 2.5, reaching14.2% of the total own-revenue generated by state and local governments (taxes, fees and charges). This represents a tax increase of $1,398 per U.S. household per year, above and beyond revenue generated by expected economic growth. In thirteen states the necessary increases aremore than $1,500 per household per year, and in five states they are more than $2,000 per household per year. Shifting all new employees onto defined contribution plans and Social Security still leaves required increases at an average of $1,223 per household. Even with a hard freeze of all benefits at today’s levels, contributions still have to rise by more than $800 per U.S. household to achieve full funding in 30 years.
As Charles Duhigg argues in the New York Times this morning, public-sector unions have a lot to do with the large size of the promises that state and local governments have made to their employees over the years. He also explains where the unions’ power of persuasion comes from: elections.
Public employee unions are hardly the only group involved in bare-knuckles politics. Businesses lobby fiercely and executives make hefty campaign donations.
But public workers have a unique relationship with elected officials, because government employees are effectively negotiating with bosses whom they can campaign to vote out of office if they don’t get what they want. Private unions, in contrast, don’t usually have the power to fire their members’ employers.
Even in recent years, as economic troubles have worsened, benefits for some government workers have grown.
This is very similar to the conclusion my colleague Eileen Norcross reached in her recent paper, “Public Sector Unionism: A Review.” In her review of the academic literature, she finds that:
Public sector unions function as a monopoly provider of labor within a bureaucratic-political realm. Public sector unionism introduces an unelected body into policy-making, thereby undermining the sovereignty of the state. Public sector employees are able to influence through political lobbying of their ―employer-sponsors‖ or politicians, who may seek to enhance union employment as a means of expanding their constituency.
[. . .]
In addition, however, public sector unions are also able to increase demand for their labor through the political, legislative, or regulatory process, thus increasing wages further than private sector unions are able to.
I wrote about Norcross’s paper here.
Of course, the public officials that allowed that system to be put in place and continued to underfund the plans for all those years are responsible, too. They are the ones who caved to pressure and kicked the can down the road. Here is Duhigg again — be sure to read the quote in the second paragraph:
But now, with the expenses of past promises coming due, the cost of deferred decision-making is mounting. California alone needs to begin devoting an additional $28 billion a year to state and local public pensions to remedy an existing shortfall, according to one nonpartisan study — and nationwide, estimates of such deficits reach into the trillions over the next few decades.
“We had no idea what we were doing,” said Tony Oliveira, who as a supervisor in Kings County, in central California, voted to increase employees’ benefits, and now is on the board of the state’s enormous pension fund. “This was probably the worst public policy decision in the state’s history. But everyone kept saying there was plenty of money. And no one wants to be responsible if all the cops quit to get paid more in the next town.”
However, things seem to be changing. Last week, also in the New York Times, journalist Steven Greenhouse reported of some of the changes happening at the state level today. He writes:
Alabama, Arizona, Kansas, Maryland, Mississippi and Oklahoma have all acted this year to require employees to pay more.
In one of the most extreme proposals, a legislative committee in Illinois, daunted by the state’s estimated $80 billion pension shortfall, voted to have state workers either contribute 17 percent of their pay toward their pensions or accept less generous pension benefits.
This is good news, but I would argue that there is a bigger policy lesson in these changes: Some promises are simply unsustainable, so lawmakers need to stop making them. Broken promises have a staggeringly high price for everyone (taxpayers, yes, but also the public employees who were kept under the illusion that the impossible was possible), on top of the cost of maintaining an unsustainable system in place for years.
(Thanks to Jason Fichtner for the pointer.)