Reform State Pension Plans Now or Pay More Taxes Later

Note: This commentary originally appeared in The (Allentown) Morning Call.

Is your family ready to lose a mortgage payment or give up cellphone service for increased property and state taxes? Or would you rather see 33,000 public school teachers in Pennsylvania — nearly one out of every three — lose their jobs? With pension costs set to drive up the average family’s taxes by up to nearly $900 annually, those are the harsh choices Pennsylvanians face unless we demand reform now.

The state’s two pension systems for state government workers (State Employees’ Retirement System) and public school employees (Public School Employees’ Retirement System) together have more than $47 billion in debt. It’s a shortfall that taxpayers must cover. And the bill is quickly coming due.

Pension reforms like those offered by Sen. Pat Browne, R-Lehigh, would take the first step to plugging this hole — but the longer lawmakers take to act, the more severe the impact.

Current projections show that state and school district contributions will increase from $2.5 billion in 2012-13 to $6.2 billion in 2016-17, representing $877 per Pennsylvania household or the salary of 33,000 teachers (based on average statewide salary). We can’t afford to simply sit by and do nothing.

School pension costs are split between school districts and the state, with some districts hit harder than others. In Lehigh County, property taxes per homeowner are expected to rise between $255 in the Salisbury Township and $511 in Allentown School District every year just to pay for rising pension costs. Allentown’s pension cost increase equates to 322 teacher salaries — that’s 31 percent of the entire teaching staff!

Property taxes per homeowner in Northampton County would rise from $211 in the Northampton Area School District up to $352 in the Easton Area School District.

Finding the right solution requires examining how we got here. In 2001, lawmakers retroactively increased benefits for themselves and for state and school employees. The following year, the Legislature passed a cost-of-living adjustment for retirees. Both increases added billions to our pension debt, and we are still making payments to cover those added costs.

Major stock market losses during recessions in 2001 and 2008 added tens of billions more in pension debt. Following these stock market declines, lawmakers voted to defer payments to avoid tax hikes — shifting these costs, with interest, onto the future. These three factors — investment losses, underfunding and benefit increases — in relatively equal portions created this crisis.

The origins of the crisis show why the current system is flawed. First, defined-benefit pensions create perverse political incentives. It makes political sense to increase benefits for current workers (voters) and transfer costs onto future generations. A child born today will be paying for our current pension deficit well into adulthood.

Further, forecasts of pension costs are just estimates. Pension fund managers project how much pensions will cost taxpayers, assuming a certain rate of stock market gains (currently 7.5 percent). When these guesses prove wrong — as they have often over the past few years — taxpayers end up owing more. A lot more.

The first step to fixing this crisis is to put new employees into a 401(k) model, also called a defined-contribution plan. This plan, which is a crucial element of Sen. Browne’s pension reform bill, puts a portion of workers’ salaries toward retirement, and taxpayers also contribute a set amount.

Such a change wouldn’t take anything away from retirees or from current workers. We must ensure we provide for the benefits individuals have already earned, while creating a sustainable and affordable system for future employees.

Defined-contribution plans would get politics out of pensions. Because funds are deposited into an employee’s personal account, it becomes impossible to increase benefits without paying for it, and underfunding requires telling workers that you simply aren’t making the required deposit in their account. Such a transparent plan prevents the political manipulation that has plagued traditional pensions.

Moreover, 401(k) plans offer convenience for employees. Younger workers especially would benefit from the ability to take a 401(k) with them as they change jobs. Putting retirement funding on a sustainable path will protect workers by ensuring the system doesn’t collapse, as happened in Detroit.

Once we stop growing our pension debt, we can find a reasonable plan for paying it off. Because of the scope of this crisis, it must include curtailing the growth of other state spending (particularly welfare fraud and abuse), adopting cost-saving measures like prevailing wage reform, and prioritizing pension payments.

Our pension crisis requires immediate action by lawmakers, as doing nothing again only allows the problem to get worse.

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Nathan A. Benefield is director of policy analysis at the Commonwealth Foundation
(CommonwealthFoundation.org), Pennsylvania’s free market think tank.