October 11, 2015

Ability Of Governments To Make Bad Long-Term Decisions - August 2008

On the September 13 New York Post,  columnist George Will wrote a column entitled “Pension Perils,” which made the same point I have made in several blogs: governments at all levels have made irresponsible commitments for unsustainable retirement benefits for government employees that the governments are unable to honor without severely cutting services or increasing taxes.

But I want to focus on a broader point Will made in his column:

“Human nature – the propensity to delay the unpleasant – rears its ugly head.  When pension benefits come due, the people who promised them, thereby buying labor peace and winning elections, are gone.”

Will might also have pointed out that, at the time these commitments were made, there was no way to account for them on the governments’ financial statements.  Even today, there is no requirement for government accounting, unlike private sector accounting, that future year costs of retirement benefits for state employees be part of current-year income statements, although, at least now, the total future cost has to be disclosed on the governments’ balance sheets.

The bigger point Will made is that it is often too easy for elected officials to make decisions that are popular today, but whose negative consequences are both too far into the future and too difficult to quantify at the time they make them.  In Connecticut, Governor Rowland entered into 20-year collective bargaining agreements with state employee labor unions in 1997, an agreement which provided for future retirement benefits that were unsustainable even then and probably more unsustainable today.  Moreover, both the active and retiree medical benefit designs are not in keeping with plans that reward plan participants for engaging in healthy, financially prudent behaviors.

He left office over four years ago, but the legacy of his decision is that Connecticut now has a total retirement benefit of around $40 billion obligation. The state has between 60,000 and 80,000 employees.  That’s right:  the state’s future retirement benefit obligations average over $500,000 per employee.

At the time that decision was made, it appeared that Rowland had gotten concessions from the union in the form of contributory pension and health plan increases.  However, any agreement that has a 20-year life and that has effects for the entire lives of those who benefit from it will have costs far beyond the tenure of any elected official.

I believe this is wrong.  No leader should be able to make significant financial commitments that significantly increase the burden on his or her successors so far into the future without a much more complete disclosure to stakeholders, and, ideally, stakeholder consent.  Even though the state employees with whom I have worked are dedicated, high-performing people whom we want to reward and retain, excessive pension and retiree medical contributions are taxpayer commitments that will cripple the ability of future governments to fulfill vital state needs, including the ability to offer competitive pay packages for future generations of state employees.

The problem with retirement benefit obligations is that, not only are they long-term, but their size is unknowable when commitments are initially made.  Medical inflation estimates change every year, and, for significant periods of time, go up.  Pension obligations appear to be more predictable because the size of the benefit is known.  However, salary assumptions can increase, as can life expectancy, and investment return assumptions can decrease.  All of these factors can combine to make pension obligations unpredictable as well.

While lawmakers have attempted to attack fiscal irresponsibility by requiring annual spending caps or balanced budgets, they have not gone far enough.  Voters should demand that lawmakers commit themselves to limiting long-term and unpredictable obligations to a small portion of the annual budget, and should require super-majorities, like 2/3 vote, to approve these obligations.  The size of these obligations, although ultimately unknowable, should be subject to the best available estimate.  Finally, there should be significant advance notice to citizens, as well as detailed disclosure of costs, to give them a chance to weigh in on these decisions before they are made.