The Miracle Of Defined Contributions

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The political power that public employee unions hold in California is enormous. Is any other lawmaking body in this country as beholden to a special interest as the California Legislature is to government union bosses? As long as that’s the case, comprehensive pension reform, as well as many other needed changes, will always be elusive.

The headline says “Florida has an answer” and if so there could be any number of public policy dilemmas that the state has solved, but in this case it’s government employee pensions. California also knows the answer, but there can be a sizable gap between having knowledge and applying it.

Once the Great Recession had passed, “Florida lawmakers found themselves,” faced “with pension debts exploding to over $38 billion in just one year,” Zachary Christensen reports in Reason magazine. It took “more than a decade of reforms,” but “the state has made admirable progress in ensuring the retirement plans for public workers don’t become an unbearable burden,” says Christensen.

“Most notably, lawmakers took an important leap in directing most new workers to a 401(k)-like defined contribution plan, which does not impose funding risks on employers.”

According to the Reason Foundation’s pension tracker, California – no surprise here – “has the largest amount of unfunded public pension liabilities, estimated at $245 billion after the 2023 fiscal year.” Yet it could be a bit more than that.

“An honest look at California’s pension debt shows the problem has grown to nearly $1 trillion,” PRI senior fellow Wayne Winegarden said five years ago after he had completed Reforming Public-Sector Pensions to Improve California’s Fiscal Outlook. He arrived at the monster figure using a market estimate to better account for liabilities and risk. Of that nearly $1 trillion, a mere 28% was funded.

Though the study was released in 2018, Winegarden says the number is still excessively high given policy changes, such as the pressure for pension managers to direct funds into environmental, social and governance investing, as well as market changes over time and current interest rates.

In order to fully fund the state’s public-sector pensions, it will be necessary for the private sector to take a hard hit. Winegarden figures it will cause the California economy to be 18.4% – or $1 trillion – smaller in 2048 than it otherwise would be.

The only way out is to fully change the California system, which primarily operates on a defined-benefit basis. In these plans, “retirement benefits are based on a formula,” according to the California Public Employees’ Retirement System, “rather than contributions and earnings to a savings plan.” This leaves governments with heavy financial burdens to meet their obligations to retired workers.

Defined-contribution plans, however, do not designate a specific dollar amount at retirement. “In these plans,” says the U.S. Labor Department, “the employee or the employer (or both) contribute to the employee’s individual account under the plan, sometimes at a set rate.” This arrangement is favorable to employers, as it lowers their risk and costs.

Like their counterparts in Florida, new government hires in California work under these terms, and have since 2013. But it’s going to be deep into the future before the savings from ​​the Public Employees’ Pension Reform Act, supported and signed into law by former Gov. Jerry Brown, are realized. Columnist Dan Walters says it’s uncertain if the legislation will ever “deliver the promised benefits.”

Public employee unions have opposed Brown’s reform plan from the onset, have tried to undo parts of it through litigation and are enlisting the federal government’s help in challenging the plan’s legality,” Walters wrote a couple of years ago in CalMatters.

The political power that public employee unions hold in California is enormous. Is any other lawmaking body in this country as beholden to a special interest as the California Legislature is to government union bosses? As long as that’s the case, comprehensive pension reform, as well as many other needed changes, will always be elusive.

Kerry Jackson is a fellow with the Center for California Reform at the Pacific Research Institute.

 

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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