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What's missing from David Cay Johnston's wage vs. benefits tradeoff

February 26, 2011

David Cay Johnston, the Pulitzer-prize winning tax-beat reporter now writing for Tax.com, finds the idea of making state workers "contribute" to their pensions to be nonsensical:

Out of every dollar that funds Wisconsin' s pension and health insurance plans for state workers, 100 cents comes from the state workers.

How can that be? Because the "contributions" consist of money that employees chose to take as deferred wages – as pensions when they retire – rather than take immediately in cash...

Thus, state workers are not being asked to simply "contribute more" to Wisconsin' s retirement system (or as the argument goes, "pay their fair share" of retirement costs as do employees in Wisconsin' s private sector who still have pensions and health insurance). They are being asked to accept a cut in their salaries so that the state of Wisconsin can use the money to fill the hole left by tax cuts and reduced audits of corporations in Wisconsin.

In one sense, he's right: total compensation = current compensation + deferred compensation. If you reduce the deferred amount, you reduce the total, so you get a "pay cut." Unfortunately, the way state politics and government pension accounting have worked together, there has been a break in the trade-off between current and deferred compensation. The deferred part has been treated like free money. This is the result of three things working together:

- The continued use of defined-benefit pension plans for government employees. These are nearly extinct in the wilds of the private sector.

- The loose standards used in measuring and funding the future public pension obligations.

- The ability of the public sector unions to choose their negotiating partners by getting their friends elected.

If the states used the defined contribution model, like the private sector, the government employees would retire based on the amount of retirement pay that has funded, rather than an amount that has been promised. Defined contribution plans impose the trade-off discipline that Mr. Johnston invokes -- you either fund wages now or you fund retirement now. Because defined contribution retirement pay increases require immediate tax boosts or spending cuts, this is not a popular model with politicians and public-sector unions.

The discipline breaks down with government defined benefit plans because there is no right-now trade-off. You can promise a higher future benefit without boosting taxes or cutting other spending today by means of optimistic actuarial assumptions. Just pretend that pension funds will always earn 8% or higher annual returns, and maybe that retirees will die off quickly. Sure, you create a funding time-bomb, but that's for somebody else to worry about in another election. There's no incentive for the unions to exercise discipline, and the politicians, largely union-funded, have been willing to bet on the actuarial equivalent of filling out a straight flush to please their funding friends. To the extent there has been any trade-off, it has been a a trade of promises of future pensions for future tax increases and/or spending cuts -- promises billed to tomorrow.

Tomorrow's here. Government defined benefit funding deficiencies range from serious to catastrophic (Illinois, California). By having some current compensation diverted to fund their retirement plans, Wisconsin employees are finally facing Mr. Johnston's theoretical trade-off in real life.

Related link: Farewell, My Lovely - How public pensions killed progressive California

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Comments

What’s missing from Joe Kierstan’s “What's missing from David Cay Johnston's wage vs. benefits tradeoff?”

I guess to be fair I’d like to start with where we agree; defined contribution plans are the way to go. I have taught at universities public and private in several states and I have a 403(b) plan from each one. For those who may not know, a 403(b) is the not-for profit equivalent of a 401(k). My employers always contributed and I always contributed; the proportions varied. The benefit, of course, is that I was 100% vested from day one; politicians of either persuasion couldn’t use it for political gain. The downside, of course, is that I live and die with the market and a few broad investment decisions that I make. A defined benefit plan would protect me from that. But, I’m fine with that and most of my peers are fine with that.

You comment: “In one sense, he's right: total compensation = current compensation + deferred compensation.” May I add that in a very real sense he is right. Those of us who bargain in a national market place look at everything; salary, benefits, cost of housing, state and local tax rates, quality of life, and even computer configuration, and so on. So, many employees in Wisconsin are in a very real economic sense paying for their pension plans. And the state wants to renege on that deal. They have a legal right to do that; but call it what it is, a pay cut for someone who is already paying their “fair share.”

My real objection is to the comment: “The ability of the public sector unions to choose their negotiating partners by getting their friends elected.” You really need some balance here Joe. Working class people need protection from big business which gets its friends elected to provide tax breaks, sweetheart deals, no-bid contracts, and other back room shenanigans which cost the state millions. In fact there’s some guy out there who seems to be running a one-man campaign against tax credits for the film industry. To imply that state employees are treated too well because of powerful unions taking the state for a ride paints a seriously imbalanced picture.

My apologies for misspelling your name Joe. A lesson in editing before pushing “post.”

Peter, as long as you are willing to read a long post and put up a thoughtful comment, spell my name however you like!

As to the substance -- I think the extreme actions that the Wisconsin senate minority is willing to take attest to the influence of the public employee unions. Few constituencies could hope to get that sort of loyalty from elected officials. It would be surprising if a constituency with that much influence didn't use that influence for its own ends, even though such ends are not necessarily in the interests of the taxpayers who pay the bills.

“It would be surprising if a constituency with that much influence didn't use that influence for its own ends, even though such ends are not necessarily in the interests of the taxpayers who pay the bills.” I agree and there are constituencies out there with much more influence and with much deeper pockets than the unions. I was looking for balance.

Despite the fact that public employee unions share with private corporations the legal right to help fund the political campaigns of candidates that support their interests I doubt that the political clout of unions, public or private, is even in the same solar system with the power of corporations to influence the actions of public officials - especially that of banks.

For example, let's compare the paltry gains of public employees due to collective barganing with the "extreme actions" taken by the Fed to bail-out private Wall Street banks and hedge funds with 13 trillion dollars of public tax money after the actions of these banks caused the collapse of the entire world financial system, a collapse that has been the indirect cause of many of the state budget "crises" that have fuled tendentious attacks on public workers. This dispersal of public funds was taken without our political representatives deigning to impose any restrictions on how the money was to be spent or any greater regulations over captial reserve requirements for speculative investments, let alone seizing these bankrupt institutions and constructing a public banking sphere to compensate the taxpayers. Fifteen million people lost their jobs, and many lost their life savings and will be losing their homes for the next 9 years due to the backlog of forclosed homes - all this to support the "private" dividends, bonuses and compensation pagackages of 1/10th of 1% of the population.

I don't know about you, but if we're going to talk about an imbalance between private gain and the public interest I think we need to start the conversation right here.

Peter:

You seem to have a fundamental misunderstanding of the issues here:

"Working class people need protection from big business which gets its friends elected to provide tax breaks"

It's not "unions" and it's not "working class:" it's the "protected class" status of public sector unions that is at the root of this problem.

In *normal* business negotiations, management and labor are, in fact, engaged in a very real, very adversarial battle: labor wants more, management (which pays the bills) wants less. Understandable.

But the public sector unions and their employers are not, in fact, on opposite sides of the table: "management" has no particular skin in the game (after all, it's not *their* money, it's the taxpayers).

And it gets worse: all the money wrested by the unions ("labor") in this scenario gets paid back to the folks on the other side of the table (other government workers in the guise of "management"). The reality is that *both* "sides" have an incentive to increase costs ("benefits").

Pretty simple, really.
Yo

BTW, all of the aboove appl;ies equally to Mr Riehle's "analysis," as well.

(And I have NO idea where that "Yo" came from)

Joe,

The Wisconsin pension plan is fully funded. So your first point is not valid as it applies to Wisconsin.

In other states it was MANAGEMENT that did not make the necessary contributions. Remember Christie Whitman, whose not putting money in will cost taxpayers there a fortune now that she is out of office? In most places where the elected officials who are management did not put in enough money the unions screamed, but to no avail.

And DB plans save taxpayers money. To get the same income flow from a DC plan requires people to demand much more money because each must individually reserve for a very long life even though many will die soon after retiring.

A DB plan takes advantage of the law of large numbers and requires a reserve for the actuarial life expectancy of the pool plus a very small margin.

In addition, DC plans violate the basic tenet of specialization. As my column at tax.com explains, to expect janitors or cops or teachers to manage money with the same skill and get the same results as professional money managers is nuts. Heck, why not have people diagnose what ails them? Who needs doctors?

David, I was wondering when you'd stop by.

When you say "fully funded," again, it depends on a lot of assumptions. It's unwise to trust politicians who have every incentive to fudge to be honest. You are correct that Wisconsin is better off than most states, and I have removed my reference to Wisconsin having a serious deficiency.

As far as defined contribution vs. defined benefit plans, you are using the term "defined contribution" to mean "self-directed." While defined contribution plans can be self-directed -- as with most 401(k) arrangements -- they aren't required to be.

The wisdom of having plan participants invest their own funds may be debatable, but many of us would prefer to make our own decisions, rather than leaving them with the financial wizards running, say, Lehman Bros., CALPERS, or the Teamsters.

As to whether DB plans "save money," the flight of the private sector from them indicates that they don't. It's clearly more expensive to maintain a DB plan than a DC plan, for any level of funding. If they saved money, business owners would embrace DB plans.

Joe, the decline of DB plans does not in anyway disprove my thesis.

1. DB plans are treated as corporate assets, unlike 401(k)-type plans, and is a serious policy error.

2. As I showed way back in 1995, the Democrats disconnected the interests of executives from janitors with their rightening of pension rules, a problem compounded by exploding CEO pay. If DB plans were required to be even across the board (as GWBush said, what's fair on the executive floor should be on the shop floor) then a CEO would have an equal interest as a janitor or clerk in a DB plan.

3. You ignored the reserve requirement, which makes DB plans inherently more efficient because you can reserve only for the actuarial life expectancy of a large group, whereas self insurance requires saving for a long lifespan even if you die soon after retirement. This is a form of insurance and there is no capitalism without insurance, though in this case it is optional and more efficient, not necessary.

4. DC plans discourage workers from retiring because each year adds to their balance and reduces the time on which they must depend on that balance. Just ask employers who found this exact problem and had to find coercive, but not quite illegal, ways to get older people to leave.

Misguided government policies do not undo economic principles, they just interfere with them.

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