The Public Pension Plan Debate

The Wisconsin Lie Exposed:  Taxpayers Contribute Nothing to Pension Plans, Forbes.com

This article has been making the rounds.  The basic thesis behind it is that public employees contribute 100% of their own contributions and that it’s a myth that the taxpayers contribute to the funds.  Therefore, the author concludes, the Wisconsin governor is trying to lower the wages of the Wisconsin public employees.

There are a ton of flaws with the author’s reasoning.  It’s true that the public workers contribute 100% of the proceeds into the defined benefit plan, but the author completely ignores the fact that the funds guarantee some sort of expected return, regardless of the underlying reality behind the returns.   This is why the private sector has shifted to 401(k)s and IRAs; private companies realized that these defined benefit plans were created with an unsustainable premise.  This might not be that big of a deal if the expected returns were set at a reasonable level, but as history has told us, politicians have tended to set absurdly high numbers for this guaranteed return.   In effect, these pension funds have acted as patronage for the public sector unions.

I’m not sure what the figures for expected returns are in Wisconsin, but I know in some states, the expected return is in the 8% – 9% range, which is significantly higher than the long-term returns on the US stock market indexes, which tend to be closer to 5% – 7%, depending on the time frame. Also, keep in mind that it’s likely that the pension funds have some amount invested in lower-yielding bonds, as well, which means they should expect a lower return than the stock market.

If you take that math as a guide, 3.5% – 5% is probably a more reasonable expectation of return, yet, politicians are promising out twice as much and expecting future taxpayers to pick up the slack. Over the course of a few decades, these discrepancies add up. Workers aren’t expected to contribute more to make up for these ridiculous expectations embedded in the assumptions, either, so the “unfunded liabilities” that the taxpayers are on the hook for have become massive.

The author admits to this after criticism, but then falls back upon the flawed idea that the workers ‘fairly bargained’ for these returns. He seems to conveniently gloss over the fact that this is precisely why the governor wants to eliminate “collective bargaining” for the public sector unions. To call this a fair negotiation is laughable; in reality, these were one-sided negotiations where the unions looked out for their own self-interest and the politicians looked out for the unions’ interests, as well.

This is why there are major problems with the entire idea behind public sector unions. Private sector unions have to deal with corporate shareholders, so there are legitimately two sides in the negotiation. Public sector unions, on the other hand, are often on the same side as the politicians and simply decide to take all the money they want and pass the burden on to future generations.  Politicians, who are elected for 2- and 4- year terms, are normally long gone before the final bill is due.

This is precisely why we need to end public employee defined pension plans and replace them with something more analogous with the private sector, such as 401(k)s and IRAs.   These pension funds are not remotely sustainable.   And public sector unions are not economically useful, since they often end up being “on the same side” as the people they negotiate against.   In other words, it’s a patronage system, and we need significant reforms.

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