Economics, Entitlements

Defending public employee pensions: I guess that’s the best they’ve got

Last week in the Wall Street Journal, Jason Richwine and I debunked the claim that typical public employee pensions are “modest,” as public sector unions claim. Average pension amounts cited by unions include both older retirees and short-time workers, whose pension benefits are much lower. A full-career public employee—the best comparison to a typical private sector worker—receives benefits significantly above private sector levels. An Illinois teacher who retired after 30 years, we showed, would receive pension benefits that put her income in the top 5 percent of all retirees in that state. To match that kind of benefit, a private sector worker would need to save around 45 percent of his income in a 401(k).

So several days later, the letters to the editor arrive. Most are actually pretty thoughtful. And then there’s the one from the American Federation of State, County, and Municipal Employees. How does AFSCME debunk our debunking? By citing the same average benefit figures we showed to be so misleading and then claiming that public employees “pay” for their benefits through contributions ranging from 3 to 10 percent of their earnings, which, as we showed, hardly pays for the full benefit.

So we debunk a talking point and they simply repeat it back. I’m not sure if that’s progress, but at least it shows that’s the best they’ve got.

2 thoughts on “Defending public employee pensions: I guess that’s the best they’ve got

  1. Andrew – You claim you “debunked” the “talking points” on average pension benefits included in AFSCME Secretary Treasurer Saunders’s letter to the Wall Street Journal. You did no such thing. You picked one system, the Illinois teachers retirement system, and imply that the benefit provided to teachers can appropriately be extrapolated to all public workers. It cannot. AFSCME’s members are not teachers. For example, the weighted average pension for a NEW pensioner in the Illinois Municipal Retirement Fund, with 20 to 29 years of service, is $19,682 according to the system’s 2010 CAFR. For employees in the Ohio Public Employee Retirement System, none of whose members are covered by Socual Security, the weighted average annual pension benefit for a new retiree with 20 to 30 years of service is $23,363 according to that system’s 2010 CAFR. Considering these figures include higher paid mangers, I think you must acknowledge that AFSCME’s assertion in the WSJ is far more accurate than your characterization, at least as it pertains to the non-teaching personnel represented by AFSCME.

    And, on the subject of misleading, your characterization of the Illinois teachers’ foregone Social Security benefit understates that benefit by 45%. You claim that the teacher would get an SS benefit of $17,750. That would, indeed, be the benefit at age 62. However, new teachers in Illinois must work to age 67 to be eligible for unreduced pensions. At age 67, the SS benefit for a teacher at an income level you cite would be $26,000 per year. If the teacher left at age 62, that would be an early retirement and the annual pension of $60,000 you cite in your editorial would be reduced by over one-third. So the difference between the pension benefit for the teacher, and what he/she would receive from Social Security, is less than $14,000 per year.

    For that benefit, teachers contribute over 9% of their pay. The state contribution for ongoing pension accruals for teachers in Illinois is just 2.3% of pay – far less than 6.2% (or currently, and temporarilly, 4.2%) Social security payroll tax or the 6% 403(b) contribution you suggest. You did not specify, but if you are also proposing Social Security coverage for the teachers to complement the 403(b), (which you should, to be comparable to the private sector) that would bring the entire state contribution to 12.2% of pay – fully 10% of pay more than the state currently contributes.

    But, as we know, Illinois and many other jurisdictions have significant unfunded pension promises and they must contribute more than the cost of ongoing pension accruals to make up for the shortfall. In the case of Illinois, and other states like New Jersey, the funding gap is primarily due to a failure of the state to pay even the modest contributions that have been required over prolonged periods. (No, Andrew, it’s not unrealistic investment return assumptions – Illinois, like virtually every other public pension system, actually has outperformed the assumed return over the last thirty years.) In the case of Illinois, the state has failed to make its required pension contributions for over three decades. This stands in contrast with responsible states like New York, Florida and Wisconsin where the pension plans are virtually fully funded.

    I won’t even begin to argue your purely academic position on “riskless” returns and a requirement that a private sector worker would have to set aside 45% of pay to match a public pension. Ironically, (or perhaps not) you made no such arguments when you were advocating private accounts on behalf of Presidebnt Bush. As a labor economist once told me: “if you torture the numbers long enough, they’ll confess to anything.”

    I’ll be looking forward to reading your correction in the Wall Street Journal.

  2. When a comment begins “I’ll be looking forward to reading your correction in the Wall Street Journal” it’s very hard not to reply.

    First, it’s not clear why you would focus on employees with an average of 25 years of job tenure. Our point was that in comparing public and private pensions you want to look at them over the same time period, the most logical of which is a full working career. Presumably a public employee with 25 years service would enter retirement with other savings, such as a 401k from a different job. Comparing his 25-year public sector pension to what a full-career private sector worker might accumulate over a 40-year or more working career is wrong.

    It’s also a little odd to focus on newly-hired IL employees. Yes, they get a bad deal — I think their deal might actually be illegal if they were in the private sector, since their contributions exceed the value of their future benefits (at least according to public pension’s funny accounting) — but they’re hardly typical of most public employees today or even of most new hires. In fact, our assumption of retiring at 62 might have been conservative; many public employees with 30 years experience can and do retire before 62. And even when public employees do suffer an actuarial penalty for early retirement, that penalty is smaller than under Social Security. All of this seems like a stretch.

    More broadly, here’s a way to think about the deal offered by public pensions. A public pension that assumes an 8% return on investment effectively guarantees participants an 8% return on their and their employer’s contributions. (Since almost all contributions and interest are paid out as benefits, that’s how the math works out.) By contrast, the highest guaranteed return available on a 401k is Treasuries, currently yielding around 2.6% over 20 years. At the end of the day, a public employee will receive higher retirement benefits even if he had the same salary and even if he and his employer made the same contributions. The implicit rate of return guarantee, backed by the taxpayer, is something public employees receive and private sector workers don’t, and it plays out in terms of benefits that are higher and safer than in the private sector.

    You can call these distinctions ‘academic’ but economists — be it academic economists, the Congressional Budget Office, the Federal Reserve or economists working in financial markets — agree that you need to adjust for differences between the two types of systems. In the Social Security debate, the Economic Policy Institute — which is labor-supported and on whose board AFSCME’s president sits — argued for risk-adjusting the returns on personal accounts down to the bond rate, which is essentially what we did in the Journal piece.

    On a personal note, you state that I “made no such arguments when you were advocating private accounts on behalf of President Bush.” As it happens, my own views have over time shifted toward hardcore risk-adjusting investment returns, but this changed point of view was clear long ago. For instance, this NBER book chapter on pricing guarantees for Social Security accounts against market risk (http://www.nber.org/chapters/c4541.pdf) was presented in 2006 and written well before then and uses exactly the same logic that I’ve applied to public sector pensions.

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