Back in December, the House passed a bill that would offset a one-year extension of the payroll-tax cut with, among other things, a reform of the federal pension system. With only a few weeks left until the payroll-tax cut extension expires, the issue is back on the table.
As I have said before, ideally the cut should be offset with a reduction in Social Security benefits. However, a structural reform of the federal pensions is also an option. In particular, a reform option that would get rid once and for all of the defined-benefit plans would be a great improvement.
The vast majority of full-time civilian federal workers receive roughly half of their retirement compensation through their defined-benefit pension plans (the rest comes from Social Security). The defined-benefit plans promise workers a guaranteed stream of income through retirement, based on earnings and time served, not actual savings toward retirement. As employers in the private sector already know from high-profile defaults such as LTV Steel’s, the promise of guaranteed income based only on earnings and time served is a recipe for fiscal disaster. While nearly 100 percent of full-time civilian federal employees receive some form of defined-benefit pension, only 22 percent of pensioned workers in the private sector are afforded this benefit.
As Peter Orszag explained a few months ago, in the private sector defined-benefit plans are largely a thing of the past:
In 1985, a total of 89 of the Fortune 100 companies offered their new hires a traditional defined-benefit pension plan, and just 10 of them offered only a defined-contribution plan. Today, only 13 of the Fortune 100 companies offer a traditional defined-benefit plan, and 70 offer only a defined-contribution plan.
Also, there are important differences between private and public defined-benefit plans. Look at this chart:
I used the data from the Office of Personnel Management (via the Congressional Research Service) and the Census Bureau 2012 Statistical Abstract to compare federal and private defined-benefit pension systems. Specifically, this chart compares the amount employees pay into their defined-benefit pensions relative to the amount that beneficiaries take out. In 2008, federal annuitants and survivors who participated in defined-benefit plans received benefits of nearly 20 times the amount current employees paid in. The data from this snapshot are consistent with the path of federal defined-benefit plans, which rely heavily on government and agency contributions for the bulk of their funding.
For every five cents that came into civilian federal defined-benefit pension plans in 2008, one dollar was paid out. Clearly, so great a gap has serious financial repercussions. In this case, since the employer is the federal government, American taxpayers are ultimately on the hook.
This explains why each year the fund which manages the defined-benefit components of the federal pension system, the Civilian Service and Retirement System and Disability Fund, receives massive transfers from the federal government (agencies, interest from federal Treasuries, as well as contributions from the general fund). As of FY 2008, the fund had an unfunded liability of $635 billion. According to the Congressional Research Service, this unfunded liability is projected to continue to increase until it peaks at $809 billion in 2030.
Whether it is part of a deal to extend the payroll-tax cut or something else, it is time to reform the system.