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Dean Baker

Dean Baker

Posted: March 7, 2011 05:36 PM

Public Pensions 101


With the recent spate of attacks on climate science and evolution it should not be a surprise that traditional defined benefit pensions in the public sector are now also under attack. There are powerful political actors in this country who are anxious to build a bridge back to the 19th century; taking us to a time where working people enjoyed few protections and could not count on sharing in the gains of economic growth.

The effort to weaken or destroy public sector unions and take away their pensions is the latest battle in this larger war. As usual, the right has been busy making things up to push its agenda, confident that the media will not expose untrue claims.

At the center of the right's story is the view that governments are somehow being reckless or irresponsible when they provide guaranteed pensions for their workers. They tell us that these guaranteed benefits will bankrupt state and local governments, imposing impossible burdens on future taxpayers.

This story can be easily shown to be untrue. While the right has been scaring the public with talk of a trillion dollars in unfunded liability in state pensions, this sum can also be expressed as about 0.2 percent of state income over the time-frame in which the liabilities will have to be paid.

In other words, if states raise 20 cents in taxes or cut 20 cents in other spending for every hundred dollars of future income, they will be able to meet their current pension obligations. This is not a trivial sum, but it doesn't seem likely to bankrupt our youth either.

Furthermore, the vast majority of this shortfall was due to the plunge in the stock market that followed the collapse of the housing bubble. Overly generous pensions were not the problem. The problem here were the greedy Wall Street types who profited from the housing bubble and the incompetent economists who did not see it. Of course the market has recovered much of its losses, so future years' pension reports are likely to show that most of shortfall has already been eliminated.

But it is important to understand the basic logic of defined benefit pensions, since many are trying to eliminate them altogether. Defined benefit pensions are in effect a form of insurance. They guarantee workers a level of retirement income based on the years that they work.

This guarantee of future income is more valuable to workers than getting the same amount of money in salary since it would be very expensive for workers to buy the same insurance from the financial industry. From the standpoint of the government, the insurance is virtually costless.

State and local governments will survive into the indefinite future. If the stock market is down any given year or set of years there is little consequence for a government offering a pension fund. Of course, a down market would be devastating for an individual worker if it happens at the point where he/she retires.

This simple logic means that governments can give workers something that is of great value - a guaranteed retirement income -- at very little cost. (Research shows that even after adding in pensions, health care and other benefits, public sector workers are paid slightly less than their private sector counterparts.) This means that because governments offer defined benefit pensions they can either attract better workers at the same pay, or the same quality workers at lower pay, than if they did not offer pensions. This is as basic as economics gets.

Not offering pensions would be comparable to a company that had beautiful grounds, with a lake and woods, and then telling workers that they could not use them. Obviously workers would value being able to bring their families to swim at the lake and hike through the woods.

When considering different job opportunities many workers would be willing to forgo somewhat higher pay to work at a company that gave them access to such facilities. If there was little cost to the company to make its grounds available, it would just be shooting itself in the foot by closing them to its workers. This is the story with defined benefit pensions; although the issue is far more important since it involves the retirement security of workers and their families.

Most private sector workers formerly enjoyed defined benefit pensions, but these pensions in the private sector are now a fast dying relic. Rather than bring about a downward leveling by eliminating defined benefit pensions for public employees, it makes more sense to take steps to re-establish defined benefit pensions for all workers.

Defined benefit pensions did not create this economic crisis. Citigroup, Goldman Sachs and the other giant banks did. It says a lot about the state of politics that these too-big-to-fail banks seem likely to survive the crisis, while defined benefit pensions may not.