Public employers can no longer afford to pay employees' share of pension costs.
As 2009 winds to a close, public employers are still scrambling to balance their budgets, and many see worsening fiscal conditions in the new year. Revenues continue to soften in many states, and costs continue to escalate for health insurance and retirement benefits. Even with wage freezes and furloughs, many public budget officers are scrambling for ways to further cut costs. Finance directors, bond rating agencies and muni bond investors are looking beyond 2010 and asking what these employers will do to structurally reduce their payroll costs in the long term.
Meanwhile, at least a third of California's municipal employers and a large number of other public employers across the country continue to pay their employees' share of pension costs, and require no contributions whatsoever for retiree medical benefits. Their pension funding behaviors are the exact opposite of private-sector employers, who have cut back on employer 401(k) contributions during this recession. I predict this will become one of the key battleground issues in governmental labor relations in the coming year.
As I've written in previous columns, the ideal ratio of employer-employee cost shares for retirement benefits is a number close to 50-50. There is no automatic best answer, because sustainable retirement benefits may be affordable for some employers with a lower rate of employee contributions. But generally speaking, there is no justification for any public employee paying less than one-third of his true costs of retirement plan benefits. (There are exceptions to this general rule in the case of sustainably funded low-multiplier non-contributory pension plans with multipliers of less than 1.7 percent times years of service times salary plus Social Security - or 2 percent multipliers without Social Security. Certain federal tax advantages can make such arrangements both cost effective and local taxpayer-friendly, as I will explain in a future column.)*
Yet few public employers have insisted on equal shares, and many have drifted mindlessly in the opposite direction. In some cases, the employers are paying the entire employees' share of pension costs, as well as the employer contributions, and requiring nothing for retiree medical (OPEB) benefits either.
Employer contributions to pension plans will double (on average) in the 10 years ending in 2014, and triple in many cases, while average public employee pension contributions nationwide remain unchanged.
Meanwhile, employers in most states are precluded from reducing retirement benefits retroactively. In many cases, they cannot even reduce the benefits formula prospectively for incumbent employees, as a result of labor contracts and, in a few cases, by state law. This leaves the financial and managerial teams with few options to achieve long-term cost reduction and reform.
For incumbent employees, oftentimes the only viable lever available for reducing pension costs immediately is to require a higher level of employee contributions. The most logical place to begin is with the plans that now pay the entire cost at employer and taxpayer expense. For OPEB plans providing retiree medical benefits, the logical starting point is to require an employee contribution of one percent of salary, and work the number higher each year. For pension plans, it may be necessary to take a more aggressive position and repeal the entire "employer-paid member contribution" in one or two years, in order to balance the budget.
Unfortunately, in states such as California, the pension plan aristocracy came up with ingenious ways to further distort this "Alice in Wonderland" thinking: They treat the employer's additional pension contribution as pensionable income to be included in the base for calculating the lifetime retirement benefit! Talk about double-dipping and pension-padding!
Every public manager who works to roll back these senseless practices will face an immediate response from tenured union stewards claiming that at some time in the distant past they "gave up" salary increases in order to achieve these unsustainable benefits. As if something was actually given to the public officials who wrote a blank check on their successor's taxing authority. Sorry, but that doesn't wash now. In a market environment in which public salaries are comparable to private workers, and private-sector unemployment is far higher than public-sector unemployment, the pension-legacy argument lacks foundation. Furthermore, private employers have cut back on pension benefits and public employers cannot, for reasons described above. Thus, the only realistic solution is to repeal the employer-paid member contribution boondoggle.
*This column was revised December 21, 2009.