By Richard D. Spiegelman
With the demise of private-sector defined benefit plans being viewed, at least in some circles, as a forgone conclusion, attention is now shifting to the question of whether public-sector DB plans will inevitably face the same fate.
The forces driving corporations to terminate or freeze DB plans are largely economic and have considerably less bearing on public-sector plan sponsors. But a different set of factors — primarily ideological arguments — are being mustered with considerable vigor against public-sector DB plans. Let's contrast the impact of each of these two effects.
• Globalization of the economy has less impact on state and local governments. They provide public services that are financed through taxes rather than sales revenues generated from the production of goods and services in competition with foreign firms. Globalization, therefore, has a much less direct and significant impact on the ability of state and local governments to sustain DB pension plans than on corporate plan sponsors whose ability to maintain DB plans rests squarely on their success competing in a global economy.
• For corporations, recently adopted and proposed changes to pension accounting by the Financial Accounting Standards Board have put further pressure on maintaining DB plans. But state and local governments face no proposed changes to the Government Accounting Standards Board rules that would broadly affect how pension assets and liabilities are reported on their balance sheets or significantly increase reported unfunded public pension liabilities. Even so, a new GASB rule will require reporting of post-employment health-care costs on their balance sheets, potentially creating additional financial stress, particularly for those governments now carrying significant unfunded pension liabilities on their balance sheets.
• State and local governments with DB plans are, in large part, bound by their pension promises. Pension benefits of government employees generally enjoy constitutional protections, which are broader and stronger than the protections provided for corporate plans under the Employee Retirement Income Security Act and guaranteed by the Pension Benefit Guaranty Corp. Thus, public plan beneficiaries are much less vulnerable than corporate plan beneficiaries to having their accrued pension benefits either scaled back or eliminated. The federal government's inability — both as a regulator and an insurer — to adequately protect beneficiaries against the consequences of corporations defaulting on their pension obligations is undermining the corporate DB system. The PBGC faces a large deficit; it is by no means obvious how the PBGC will ultimately be able to meet its obligations. In the face of these facts, it is little wonder not only that corporate executives are questioning the wisdom of perpetuating DB pension plans, but also that workers, especially younger workers, may be losing confidence in and showing less enthusiasm for DB plans.
• While private-sector unions have been declining both in strength and coverage over the past several decades, public-sector unions have been expanding and growing stronger. Generally, large corporate pension plans were established decades ago in unionized firms when private-sector unions were at the peak of their power. In contrast, companies established and rising to prominence during more recent decades are both less likely to be unionized and to offer DB pension plans.
• Finally, the trend toward greater job mobility and the attendant losses from the lack of DB pension portability experienced by private-sector workers are less pronounced in the public sector, where workers tend to be less mobile and where multiple public-sector employers often participate in common statewide pension plans.
What, then, lies behind the efforts mounted in a number of states during recent years to move to DC plans from DB plans?
These efforts have been driven and inspired at least in part by groups with a single-minded anti-tax agenda and a desire to reduce the size of government generally. Replacement of DB with DC plans is seen as broadly forwarding both of these objectives to the extent that it reduces public employee compensation. Whether any specific proposed DB to DC shift actually does reduce overall employee compensation costs depends of course on the particulars of the proposal, the most important of which is the employer contribution to the DC plan. Given the stiff opposition these proposals have encountered from public-employee unions, and the relatively small percentage of employees who have elected to enroll in DC plans where these were presented as an alternative, it is reasonable to infer that these proposals would, in fact, reduce overall public employee compensation.
Besides their general desire to reduce the size of government, the proponents of eliminating public sector DB plans make a number of subsidiary ideological arguments. They believe that individuals — as opposed to government generally or government in the role of employer — should bear more of the investment risks associated with saving for retirement. This belief drives not only their opposition to public sector DB plans, but also to Social Security. As a corollary, they see DB plans (and Social Security) as a sort of forced collectivization which deprives individuals of the right to invest their own money. And finally, these proponents believe that public-sector DB plans concentrate too much power and control over a large amount of financial resources in the hands of plan trustees and staff, enabling these public officials to then meddle in issues such as corporate governance and corporate responsibility.
Will these ideological arguments drive public-sector DB plans into the same downward trajectory that corporate DB plans appear to be on? For the moment, these arguments seem to have lost some steam, and pressures for the freezing and conversion of public-sector DB plans may be subsiding. Make no mistake, however; such pressures may quickly resume, particularly where public plan sponsors fail to maintain contribution rates adequate to fully fund or at least move substantially toward full funding of the systems they oversee. Such underfunding presents a danger to the continued existence of public-sector DB plans. That danger is not so much because the underfunding threatens the future financial security of plan beneficiaries — after all, unlike corporate plan sponsors, state and local governments are on the hook to make good on their pension promises in any event. Rather the danger arises from the fact that persistent underfunding over long periods of time creates intergenerational inequities. Future taxpayers who are left holding the bag for costs that should have been borne by yesterday's or today's taxpayers will be more likely to rise up in anger and react by scrapping public DB plans altogether.
Richard D. Spiegelman is chief of staff in the Treasury Department, State of Pennsylvania, Harrisburg.