Fred Zimmerman: That money is washing away

  • Article by: FRED ZIMMERMAN
  • Updated: October 25, 2009 - 11:42 AM

There's a growing public workforce, retiring early but living longer while drawing benefits. Do the math.

British scholar John Argenti said that failing organizations rarely go under because of severe external conditions. They usually fall prey, he said, to normal hazards after the organization has been weakened by incompetent management. Weaknesses of this kind are plentiful in American public policy today -- consider deficits and energy policy, among others. But there may be no better example than the festering problem of mushrooming and underfunded public retirement funds. The basic problem is that pension funds created to finance retirement benefits for thousands of public employees -- teachers, police officers, firefighters, and state, city and county workers of every description -- lack sufficient funds to meet their obligations. The result could be sharp reductions in future benefits, significant tax increases, or both.

Minneapolis Mayor R.T. Rybak brought the scale of the situation home in his budget address last summer. He reported that nearly two-thirds of an 11.3 percent property tax hike next year would go to fund the city's pension obligations.

There are, of course, many dedicated public workers across Minnesota and the nation. Indeed, their numbers have soared, and that's part of the challenge.

In 1950, about two-and-a-half times as many Americans were employed in manufacturing as in government -- 15 million in manufacturing, 6 million in government. Today, governments have 22.5 million employees, while manufacturing has 13.4 million.

No state has added either construction or manufacturing employees in the past recessionary year. But 32 states have added government employees.

These dramatic shifts in the nature of the American economy raise questions about the future of tax revenues.

Early retirement ages for public employees worsen the retirement funding problem. The stresses of a competitive global economy have forced many people in the private sector to work well into their later years, often into their 70s if they can find work. Public employees often retire much earlier, sometimes during their mid-50s, usually with richly provided defined-benefit programs -- and sometimes with substantial bonuses to retire early.

Meanwhile, life expectancy has been rising, while retirement ages have largely remained unchanged. The combination is fiscally lethal.

The Minnesota Teachers Retirement Association has reported that the average teacher is now expected to receive defined retirement benefits for more than 27 years. Total cost: roughly $1 million per retiree.

Retirees in the program range in age from 52 to 108.

Predictably, retirement rolls have grown as more and more workers reach the easily achieved age. California's retiree ranks grew by 36 percent in just nine years, while benefit payments increased by 127 percent. Many states experienced similar growth rates.

Costs escalated further partly because of built-in benefit raises inherent in many public pension systems. Minnesota retirees receive 2.5 percent annual increases and, occasionally, additional increases. Inevitably, such arrangements cause benefit payments to outstrip the abilities of active employees and employers to make sufficient contributions to keep the funds whole.

Rapidly accelerating retirement payments have made it difficult for fund managers to earn large enough investment returns to keep the funds financially secure. Fund managers have responded by seeking higher yields, and returns have occasionally been quite good -- when the markets were high. But higher yields often come with greater risk, and that well-established axiom proved true in the past year's turbulent markets.

Minnesota's basic retirement fund lost 19.6 percent of its value from July 2008 to July 2009.

Delaying the reckoning

The escalating burden of retirement benefits has strained the finances of core government functions such as education and law enforcement. Additional contributions to public pension funds are urgently needed. But recipients, administrators and timid legislators are unwilling to acknowledge this.

Minnesota sidestepped the pension crisis during the past legislative session. But a massive infusion of funds is being proposed for the next session. The added costs will make balancing the state's budget even more difficult.

Several water-muddying mechanisms have been devised by public officials to reduce anxiety and further delay the day of reckoning. Insiders might describe it as carefully formulating actuarial assumptions about future revenues and costs. Others might describe it as cooking the books.

State administrators appear reticent to own up to an obvious but unrecognized problem requiring billions of dollars to correct. Retiree organizations seem reluctant to call the public's attention to the true cost of the benefits they have been receiving. Courts seem reluctant to interpret the constitutional requirement of a "balanced budget" in accordance with proper accounting conventions.

Three responses to the problem of unfunded public pensions seem possible: First, retirement ages could be increased to the age of 70 or so, and benefits could be reduced to levels more common in the rest of the economy.

Second, taxes could be increased to cover the current shortfalls. However, any proposed tax increase will seed its own conflict -- a sort of "prisoner's dilemma." Who should pay the tax? Nonpublic employees who are working into their 70s who did not get the money? Or retirees who did get the money? Or current public workers who may never get the money? Widespread satisfaction is unlikely.

A third possible response seems imprudent, but more likely: Kick the can down the road again. Ignore arithmetic and pretend the problem does not exist -- a technique now employed in several states.

The likely epicenter

On the surface, the pension problem may seem like a classic conflict between taxpayers and public employees.

That is too simple. Given government's tendency to leave serious problems unattended, the eventual conflict is more likely to erupt within the ranks of the public employees themselves. There will probably be enough money to provide older employees and existing retirees with more lucrative benefits than they would normally receive in the private sector. But when the money runs out, as it inevitably will, younger employees might well face devastation and a cruel curtailment of what they have been contributing toward and counting on.

In the end the problem of underfunded public pensions is not a political problem. It is an arithmetic problem. There is simply no way that an economy engaged in intense international competition can generate enough disposable income to fund premature retirements of able-bodied, often-dedicated public employees when life expectancies are increasing as they are.

We should approach the problem without rancor. It is in the best interest of all to work out a realistic solution that does not tax those who have not benefited.

Fred Zimmerman is professor emeritus of engineering and management at the University of St. Thomas.

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