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Policy: Budgets & Deficits

There is a way out for states trapped in the pension sinkhole

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Opinion,Op-Eds,Oklahoma,Utah,Michigan,Budgets and Deficits,Pennsylvania,Public Employee Unions,Pensions

Across the nation, states and cities are struggling to keep up with their obligations to fund state worker pensions.

Detroit--desperately trying to reduce its obligations in federal bankruptcy court--is the classic example. But the financial sinkhole swallowing Detroit is spreading throughout the country at an alarming rate.

In New Jersey, Republican Gov. Chris Christie is likely to dodge $2.3 billion in required pension contributions over the next two years to avoid either massive tax hikes or service cuts.

Illinois is battling to get its state pensions under control, and Chicago just hiked taxes to cover its obligations.

The problem? Under “defined benefit” retirement programs, public employees have been promised more money than states can ever afford to pay.

According to Stanford University economist Joshua Rauh, Pennsylvania's public pension systems are at risk of running out of money by 2023, even if the market returns 8 percent per year.

But in a new study I conducted for the Commonwealth Foundation titled “Stopping the Sinkhole,” I suggest that while it may come with some costs, shifting future workers from a defined-benefit system to a defined-contribution system — like a private sector 401(k) — would have significant benefits.

A shift to a direct-contribution model will not suddenly guarantee that Pennsylvania is out of the woods when it comes to its pension problems, but it will place something like a cap on the growth in unfunded liabilities.

The $50 billion of debt on the state's books, of course, will still have to be addressed, but a shift to direct-contribution could put a stop to the steady bleeding.

The good news for Pennsylvania is that we have countless examples of successful transitions in the private and public sectors.

Thousands of companies have made the shift from direct-benefit to direct-contribution over the past 30 years, and many surveys indicate that employees are more satisfied with the portability and ownership that accompanies the newer plans.

With workers changing jobs about 10 times in their careers (and often leaving the state for employment), direct-benefit plans have not kept up with the changing nature of the labor force.

Along with examples and stories from the private sector, a growing number of states and municipalities have reformed their pension plans over the last 20 years.

The state of Michigan was one of the first to shift new workers to direct-contribution pensions back in 1997, and it’s estimated that they have saved nearly $200 million in costs over the last 16 years and have avoided between $2.5 to $4.5 billion in additional unfunded liabilities.

More recently, the state of Utah shifted to a direct-contribution plan and the transition has been an unambiguous success.

And, just this month, Oklahoma's legislature passed reforms that will shift many new public employees to 401(k)-style plans.

Starting in 2015, the plan for new Oklahoma state workers requires them to set aside at least 3 percent of their salary with the state matching up to 7 percent. This reform will provide taxpayers far more predicable costs going forward.

The most important winners in pension reform, though, are public sector employees.

Public employees now earning direct-contribution returns will no longer have to make endless calculations about how long they will be “job-locked” just to “vest” in their pension.

Most importantly, they won’t have to worry about the instability that comes from relying on politicians to manage their money.

The uncertainty of politicians raiding healthy state pension funds will evaporate.

There are other states likely to be adopting the Oklahoma pension model soon. As they do so, taxpayers and public sector employees in the reforming states can rejoice.

In an economy where growth, jobs, and investor dollars are desperately needed, Pennsylvanians cannot afford to wait much longer on pension reform.

The examples from the private sector and states like Michigan, Utah, and Oklahoma make clear that long-term, sustainable reform is possible.

Scott Beaulier is chairman of the economics and finance division and director of the Johnson Center at Troy University.
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