Pension Prognostication Problems
As the failure of major public pension funds looms on the horizon, talk is of how to resolve the issue.
R. Eden Martin, in a well thought out essay in the WSJ, makes various recommendations that would resolve part of the problem, but his thought, and that of most others, treats the symptoms and not the problem. As no one seems interested in treating the problem, perhaps an explanation of what the problem is would help.
The problem is, in the simplest of terms, under funding. This is so simplistic that it seems obvious. But if it were obvious, like potholes in the road are, perhaps something would be done. This is because the term “under funding”, being simplistic, avoids examination of the problem and so makes avoidance of the problem an easy choice.
Pensions, retirement plans, and Social Security are understood to be funds available for payment to workers, or their beneficiaries, when the workers withdraw from the work force. This withdrawal does not mean a reduction in, nor is it associated with, the retirees expense, but means only they will leave the work force and be paid a predetermined amount during said withdrawal or retirement.
The question is where does the money come from? More accurately, what does this money the retirees expect to be paid represent? This is the critical question and it is the one that must be addressed if we are to repair the dysfunction of current pension plans and move into a fiscally reasonable future.
Payment for retirees is of two sorts. It is either money set aside during the retirees working career, or it is money taken from those still working after the retiree withdraws from the workforce. Typically public employee pension funds are written as part of an employee’s benefit package to enable the state to hire people at lower wages than they would expect in private business. This is fine, but in order to properly fund those retirement benefits someone must do the work that the payment to the retiree represents.
This is the crux of the issue.
If a retiree is led to expect a monthly benefit of $4,000 at age 60, which will pay them until death, perhaps 25 years, then someone has to come up with $1,200,000 in cash to make those payments. If the expectation is that the pension fund was supposed to accumulate that money during the working career of the employee, then during those 30 or so working years the pension fund should have been collecting $3,333 per month towards that end.
For the employee making $90,000 per year, the cost to the state, or employer, should have been $130,000 per year. The point here is that the retirement funds must be taken as taxes at some point. Someone must work to produce something that can then be taken from them as taxes in order to pay the subsidy to the worker who has withdrawn from the work force. This can be done during the tenure of the employee as an employee or it must be done later. There are few options.
The point in taking the money and actually placing it into a retirement fund is that retirement funds are real money which represents work someone has done in order to later pay the retiree to do nothing. Let me reiterate: someone must work to make the payments so retirees can do nothing yet continue to consume. This work was either done by the worker during his career, or it is done by someone else, but someone has to work and transfer their earnings to the retiree.
So if the state, as the employer, believes a worker is worth $130,000 per year when working and takes a set amount of that each year to fund a retirement fund and the current payroll, there is no problem. However, that has not happened, which is the reason for the concern about under funded pensions. Governments have paid the employee, but have not properly paid the retirement fund. They have avoided doing this because in order to do so they would have had to tax the general population at much higher rates than they did.
As is typical of politicians in fiscal matters, they have postponed the reckoning into the vague future for someone else to deal with. Because of their irresponsible action there has not been enough work done by someone, taken in the form of taxes, to pay for the worker who wishes to withdraw from the workforce to live on. Thus there is not enough money to pay the obligation, hence the term “unfunded liability”.
This under funding, more accurately, under-taxing and over-obligating, is true in many government retirement funds, including Social Security. Government pensions have played a ponzi scheme by putting the partial funding in stocks and bonds, expecting them to grow fast enough to offset the actual fiscal policy decisions, knowing full well future taxpayers are on the hook for their misleading decisions. This results in avoiding full funding of pensions, and putting off into the future the actual tax requirements of the promises made in current budgets. As retirements don’t come due for years, those legislators who made those untenable financial decisions are often no longer in office. They will not be held responsible, and the credit for making funds fiscally sound will fall on those in the future.
The future is here.
Promises were made which cannot be kept. This is true of all retirement plans including Social Security. Either the taxpayers or the retiring worker or some combination of both will lose some of what was promised. The taxpayer through higher taxes, the withdrawn worker through lower than promised payments.
We must reexamine our policies and promises. They must be fiscally sound for the future, not just politically comfortable for today. It is a moral requirement most politicians are incapable of understanding because their focus is on reelection. That being said, the people must require it of their representatives. “Truth in pensions” one might call it. It is a lofty expectation. It shouldn’t be.
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