Taking power away from labor won't rescue states from their fiscal woes--but giving power to voters might.
The real cause of the crisis is the inherent conflict of interest politicians face when they have the option of handing out or maintaining pension promises to favored constituencies, including themselves, without the public understanding what’s going on and without the bills coming due until after they are gone from office. Politicians have two basic ways of doing this. First, they can, as Republican Christine Todd Whitman and subsequent governors of New Jersey did, simply stop contributing money to the pension fund or tap their credit card to pay the pension mortgage. This is especially easy to pull off during periods of irrational exuberance. In 1997, Whitman had New Jersey borrow $2.7 billion in pension obligation bonds on the assumption that the state could use the money (or what was left of it after the tax cut Whitman had promised in order to win the election) to make a big kill on Wall Street. When New Jersey’s investments went south, it was stuck not only with the cost of servicing the bonds, but also with a giant hole in its pension fund. Illinois did the same thing in 2003, by borrowing money from Wall Street at 5.5 percent on the assumption that it could make 8.5 percent by investing it on Wall Street. Predictably, this Wizard of Oz fund-raising hasn’t worked out. In December 2010, Illinois’s then comptroller, Dan Hynes, was on a segment of 60 Minutes saying that he had $5 billion worth of bills in his office and no money to pay them. Unable to even pay its other bills, Illinois is now proposing to issue another $3.7 billion in bonds to make this year’s pension contribution.
Politicians can also make benefits more lush without coming up with the money to pay for them. That’s what happened in California in 1999 under Democratic Governor Gray Davis, when the state enacted the largest pension increase in its history—one that now has become the single biggest threat to the state’s continued solvency. For regular employees, the legislation reduced the age at which unreduced benefits could be claimed, from sixty to fifty-five. For highway patrolmen, it left the age for claiming unreduced benefits at age fifty but sweetened the benefit formula by 50 percent. For peace officers and firefighters, the new enriched formula applied at age fifty-five and after. The bill also provided an added cost-of-living adjustment on top of the annual adjustment built into the existing system.
Who was responsible for figuring out how much these other technical changes in the big benefits bill would cost? Why, the actuaries employed by the California Public Employee Retirement System, of course—whose own pensions would be enriched by the legislation they were being asked to evaluate. Not surprisingly, the actuaries declared the bill easily affordable, though in fact, as we now know, they underestimated its cost by a factor of five.
And who made the final decision? Why, the members of the California legislature, Republicans and Democrats alike—who, like the actuaries, would see their own pensions increased by passage of the bill, and who would win votes from public employees if they voted yes. The pension bill passed 39-0 in the state senate and 70-7 in the assembly, while barely making the papers. As far as the average Californian could tell, the big news out of Sacramento that day was passage of a bill to provide gay students legal protection against abuse and an agreement to allow expanded Indian gambling operations around the state.
So this is the world as we find it. Government decisionmakers face an inherent conflict of interest when it comes to making pension policy for government employees, and so do their staffs. This is true whether or not unions are involved. Beyond the enticement of self-dealing is the temptation to self-aggrandizement that comes when politicians are allowed to take credit for delivering benefits whose full cost only becomes apparent after they are long gone. That all this can be done within a tight circle of insiders without the press or the public taking much notice only further perverts the logic of decisionmaking.
There is another realm of government where much the same misalignment of incentives applies, and what we do to check against it suggests an answer for how to deal with the pension crisis. When a city or state is considering whether to float bonds to finance a major project, like building a school or a highway, the rule almost everywhere is that the issue has to be approved by referendum. In Wisconsin, for example, no school board can commit to a capital project of more than $1 million without taking it to the district for a vote. That’s because otherwise there is too little check on politicians borrowing from the future to benefit their favorite contractors and other constituents. With so much backroom self-dealing possible, sunshine and direct democracy are a necessary corrective.
We could easily apply the same rule to public employee pensions. Let the unions and the politicians negotiate all they want, but if they come up with a contract that puts future taxpayers on the hook for the cost of making pension and other retirement benefits more generous, it should go to a vote of the people. If the people are feeling generous, or if they feel there is indeed a strong case for why public employees need more generous pensions, they may well go along. If they feel there are more compelling purposes for which they should be spending their own or their children’s money, they will not.
Just by being on the ballot, these questions would attract more press attention to the issue of pension finance, give a greater platform for government watchdog groups and disinterested pension experts, and promote better public understanding generally of the trade-offs involved, all of which is sorely needed. The League of Women Voters would print brochures explaining the pros and cons. Newspapers would weigh in with editorials. In contract negotiations, politicians and other insiders would know that whatever deal they struck would have to win a majority vote of the people—who will ultimately have to pay the bill. It might mean that public employees wouldn’t see another pension hike for another generation. So be it. That would give the majority of Americans who lack pensions some time to organize and catch up.
Referendum is, of course, not a perfect solution. By itself it does nothing to reduce the cost of the pension promises already made, many of which are protected by state constitutions as well as ordinary contract law. (Eliminating collective bargaining rights for unions won’t solve this problem, either.) It’s also important to apply the same strict regulation regarding how liabilities and rates of return are calculated in public-sector plans as is now generally found in the private sector. But going forward, subjecting pension enrichments to the vote of the people would both grant public workers the right to collective bargaining while also giving much stronger protection to the public from existing moral hazards we can no longer afford to ignore.
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