A few notes on public employee pensions

And continuing the series on retirement

Mrs. Krabappel died before she got to collect her pension.

Last week, I started writing about the 401(k) problem, and it’s a big one. One related issue is public employee pensions, which tend to confound people in the private sector.

There’s two things you need to know upfront. The first is that under the US Constitution, the federal government has limited oversight of state and local governments. As long as state and local governments do things that are constitutional, the feds can’t do anything. Social Security is a federal system, ruled by federal laws. Private employers have to participate. State and local governments do not have to, although some have opted into the Social Security system.

The second is the time value of money. A dollar today is always worth more than a dollar in the future. When you invest money, you give up the use of the funds, and inflation will cut into your earnings power. You expect more to compensate you. This also means that money you will receive in the future costs less today. You can offer people more money in the future at a (relatively) low cost today, something that Carmen Policy of the San Francisco 49ers figured 30 years ago to transform sports compensation.

The leaders and legislators of governments that chose not to participate usually figured that they could deliver better benefits for less money. They figured that they could do it through savvy investing rather than higher taxes. This is sort of true, because government pension plans tend to be huge investors in such alternative assets as private equity, real estate, and hedge funds. CalPERS, the California Public Employee Retirement System, is now invested 40% in alternatives. But it’s also sort-of not true, because a lot of states are nowhere near fully funded.

But, like Carmen Policy, state and local government leaders realized that it was often cheaper to give public employees large future pension benefits than it was to give them raises now. While many public sector employees earn less in regular pay than people in equivalent private sector jobs, they receive larger pensions. Some people like this. Not everyone does; most college students are looking at starting salaries, not lifetime total compensation, when choosing majors.

A few things are true:

• Many state and local pensions are designed to combine both Social Security benefits and traditional pensions.

• Many state and local employees accepted lower starting salaries in exchange for higher future benefits.

• Changing state and local pensions (for example, by opting into Social Security, or by cutting pension benefits in favor of higher starting salaries) would be costly for taxpayers.

• The “lost decade” following the financial crisis, with near-zero interest rates and flat stock market returns, hit public pension funds hard.

• Because so many public pensions are heavily invested in real estate and private equity, there is some reluctance to regulate these sectors because it would hurt the already-fragile funding status of these plans.

I’m not sure what the answer is. Speaking as a Chicagoan, a lot of people loved it when Richard M. Daley was mayor, because he spent so much money on the city without raising taxes. It was only when he left office that it became clear that he spent money that he did not have. He even sold the city’s parking meters at a bargain price, ostensibly to create a rainy-day fund, but it only plugged a single year’s deficit.

All of which is to say, most people don’t complain unless their taxes are going up. This gives politicians an incentive to kick the can down the road. And since we vote for the politicans, the problem is ours.

Long story short, like all pension issues, it’s complicated and expensive.

What do you think? Be nice.