The changes approved throughout the 2010s included a mix of benefit reductions, contribution increases and investment-assumption changes that — in combination with strong market performance — improved aggregate nationwide pension funding levels from 62 percent in 2009 to over 80 percent today. Yet despite these improvements, plan funding remains below pre-2008 levels, and the gains could be quickly reversed by a market correction mirroring the 20 percent loss experienced in 2008.
To fully appreciate the risks associated with the policy changes under consideration today, it’s worth pausing to look at how public pensions fared in the decade preceding the Great Recession. On average, plans entered the 2000s fully funded, thanks to strong investment performance throughout the 1990s. However, rather than using these strong funding levels as a buffer against a future market downturn, some states used them to finance benefit increases for workers while others lowered contribution requirements.
Then, in 2000, the dot-com bubble burst, resulting in a recession that drove pension-funding levels below 100 percent and kicked off an era of rising pension contributions for state and local governments. The markets rebounded relatively quickly, which helped restore funding levels into the 90 percent range by 2007. But this also reduced some of the pressure on policymakers to enact smart structural changes that would have put pensions in a better position to weather the next economic downturn. Unfortunately, that downturn happened the next year.
The severity of the 2008 crisis and the resulting funding declines gave lawmakers across the country no real choice but to take action, including requiring contribution increases from taxpayers and workers to pay down pension debt as well as the enactment of new benefit tiers to curb pension liability growth. But benefit changes some states are now considering could set the stage for another damaging round of funding declines and contribution increases when the next economic contraction occurs.
California provides one of the most prominent examples of a state considering pension legislation that would unwind previously enacted reforms. In 2012, state lawmakers approved the Public Employees’ Pension Reform Act (PEPRA), which created a new tier of benefits for public workers hired after Jan. 1, 2013. Major changes in the new tier included raising the retirement age, reducing the benefit formula and establishing new contribution requirements for public workers. At the time, the California Public Employees’ Retirement System (CalPERS) projected over $42 billion in long-term savings from the reform.
The PEPRA changes applied only to new hires because California has some of the nation’s strongest pension protections, precluding benefit reductions for existing employees. As a result, the number of workers covered by the new tier and the resulting cost savings started small and grew over time. After 13 years of enrolling new workers into the PEPRA benefit tier, CalPERS reports that these workers now account for two-thirds of active employees and that the reform has generated nearly $6 billion in realized savings — savings that are projected to grow by another $26 billion as the PEPRA workforce expands to 90 percent of the total during the next decade.
However, these projected savings and other structural improvements created by PEPRA are under threat thanks to the passage in January of Assembly Bill 1383 by a margin of 70-2. Now awaiting consideration in the Senate, the bill would unwind core components of the 2012 reform by increasing pension benefit formulas and lowering public safety workers’ retirement age from 57 to 55, at an estimated cost of more than $300 million a year.
California is not the only state attempting to reverse pension reforms approved in the 2010s. New York is in the midst of a strong push to expand pension benefits for public workers enrolled in its Tier 6, established by legislation in 2012 and projected to save state and local governments $80 billion over 30 years. Today, lawmakers are considering proposals to “Fix Tier 6” by reversing the 2012 changes that lowered benefits, raised the retirement age and required workers to contribute more toward their retirement.
In Arizona, lawmakers have recently considered legislation that would allow earlier retirements and shorten the cost-of-living adjustment (COLA) waiting period for police officers and firefighters enrolled in a decade-old benefit tier that was designed to help stabilize the state’s underfunded pension plan for first responders. Meanwhile, recent bills in Georgia and Florida would reinstate automatic COLA policies that were eliminated in 2009 and 2011 as part of each state’s response to the financial crisis.
Regardless of the specific changes being proposed, lawmakers should consider these types of benefit increases with a high degree of skepticism and ask proponents to explain the cost of the increases not only if investments perform as assumed but also under scenarios when investment returns fall short of expectations.
Pension funding has undoubtedly improved since 2010, in large part due to reformed benefit structures and fiscal discipline, but states still face nearly $1.3 trillion in total pension debt and an uncertain economic outlook. This means that taxpayers remain on the hook for substantial pension liabilities for years to come, and granting a benefit increase to workers elevates the risk of adding to this debt burden, which in the worst-funded states can exceed $10,000 per capita.
The reforms enacted over the past two decades were successful in part because the burden was shared between public workers (in the form of less generous benefit packages) and taxpayers (in the form of contribution increases). Granting relief to some workers while shifting the burden to taxpayers turns on its head the very approach that has been successful. Lawmakers should avoid repeating past mistakes and instead stick with the current policies that are achieving measurable improvements in pension sustainability.
Chris McIsaac is a fellow with <i class="rte2-style-italic">the R Street Institute</i>'s governance program.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
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