THE BLOG

Public Pension Reform and the "Little Engine That Could"

11/08/2011 09:28 am ET | Updated Jan 08, 2012

Rhode Island's General Treasurer Gina Raimondo is easily my nominee for the "Little Engine That Could" award.

Her politically courageous efforts to reform her state's broken and dramatically underfunded $14.8 billion public pension system are a high-stakes, against-the-odds example of lofty political leadership that deserves accolades. And if she succeeds, then a road map of acute sensitivity and wise choices will exist for every other Treasurer in the Union to follow.

Here are the facts -- and sobering ones they are.

Rhode Island's state pension fund now consumes 10% of every state tax dollar, and this figure is currently projected to double within just the next few years. In addition, there at least 155 (!!) municipal pension plans in Rhode Island outside the state system that are in the same dire straits. As Treasurer Raimondo recently said in describing her challenge, "Either the pension fund runs out of money or cities go bankrupt." The small town of Central Falls, north of Providence, already has failed financially.

And the root problem? Until just this year, Rhode Island calculated its pension number by assuming an average annual rate of return on its investments of 8.25% -- in fact, for the last decade its actual average return on investment was only about 2.40%. And in each of the last 10 years the state's fund paid more money to retirees than the fund collected from state employees and taxpayers combined. The same can be said of most of the many municipal funds and their towns' employees and taxpayers.

Rhode Island is a microcosm of what's wrong with the country's $3 trillion worth of public pensions plans in the aggregate, and it's truly the 'canary in the (national pension crisis) coal mine'. The state -- just like 49 other states -- made promises it didn't sufficiently fund along the way and now can't keep. That bill has come due, so to speak, and as Treasurer Raimondo describes, the state is being forced to choose among the state reneging on both past and future promises to workers, undermining its future by cutting back on investing in everything from schools to green energy to health care, or, even though in the midst of an ongoing recession, raising revenues through large tax increases.

I have met with Treasurer Raimondo, and few in the country seem as capable intellectually and policy-wise of sensitively and fairly cutting this Gordian Knot. And it took great political courage for her to step into this breach, courage of the sort we need to see more of in every State Capitol.

I particularly applaud Ms. Raimondo's outspokenness and transparency as she balances between keeping as many of the state's promises as she can while preserving the state's ability to serve its people and invest in its future. Too many other officeholders -- in Ohio and Wisconsin, just to name two states -- are using their state pension problems as an excuse to eviscerate the status and compensation of public employees and take away their rights to fair bargaining.

The proposed Rhode Island Retirement Security Act of 2011 (RIRSA) would move to a combined defined benefit and defined contribution plan that fairly spreads the market risk of the system across both taxpayers and employees. Going forward, state employees and teachers will pay a smaller amount of their paychecks into the defined benefit system, but will henceforth also contribute into their own retirement accounts. Smartly, until the entire system is again financially healthy and at actuarially acceptable funding levels -- i.e., no more 8% 'gaps' between assumed and actual returns on investments -- cost of living adjustments or COLAs will be suspended. And to put the state properly behind the reforms, protections similar to those now found in the Federal Pension Protection Act will be the "law of the state". Finally, vitally important albeit somewhat nuanced, there will be self-correcting mechanisms to ensure that Rhode Island never faces this challenge again.

The only place I disagree with the Treasurer is in moving the retirement age past 65, which is the same recommendation which the so-called "Deficit Commission" made last November related to Social Security.

The premise behind the recommendation to increase the retirement age from 65 to 68 or 69 -- namely, that average life expectancy is rising -- may sound OK but in fact it is flawed in the extreme and equally insensitive. While life expectancy is indeed rising, it's doing so mainly for high earners who least need pension plans (and Social Security) -- for those in the bottom half of the income distribution, which includes the preponderance of state workers, life expectancy hasn't budged for 30 years. A better alternative -- for the states and for federal Social Security -- is to eliminate any caps on taxable wages beyond which self contributions to either a pension plan or Social Security cease. (In the case of Social Security, rather than (again) penalizing the hardest working Americans there should also be "means testing" so that only those individuals who need it get it.)

But this suggested alternative is just one nit to an otherwise perfectly fair solution to the unprecedented financial crisis confronting Rhode Island. Even though the state's public employees and retirees must feel betrayed as they are asked to concede some of what had been promised to them, they must understand that it was those who made the promises and then administered the plans with faulty assumptions who let them down.

And when RIRSA, or something very close to it, is enacted by the Legislature, then Rhode Island really will be the "Little Engine That Could".

Leo Hindery Jr. is chair of the US Economy/Smart Globalization Initiative at the New America Foundation, co-chair (with Leo Gerard) of The Task Force on Jobs Creation, founder of Jobs First 2012, and a member of the Council on Foreign Relations. He is the former CEO of AT&T Broadband and its predecessors, Tele-Communications, Inc. and Liberty Media, and is currently an investor in media companies.