Tag: kentucky

Richard Riordan and Alexander Rubalcava have an op-ed today arguing that the central problem associated with state pensions are the weak incentives to “improve pension performance.” Presumably, they mean that pension returns have been anemic for the past decade and quite bad in the last couple of years and we just need to boost those returns.

But of course, that’s not the central problem with state pensions. The central problem is, in a sense, the maturity mismatch between the pledges to create and enhance benefits to retirees and the actual benefit payments themselves. Lawmakers have for years enhanced pension promises even as the unfunded liability has grown dramatically. Why? Because the short-term benefit to lawmakers of boosting benefits and excessive hiring far exceeds the political costs of the inability to pay down the road.

That mismatch has allowed lawmakers to reap political gains while letting the costs accrue to taxpayers years or decades down the road. Unfortunately for taxpayers, poor economic performance and a wave of retirements mean the bills are coming due sooner than expected.

But that’s really only half of the problem. Riordan and Rubalcava only make a passing reference to the fact that the expected (government-determined) rates of expected return are what pension funds use to determine the size of the liability. The higher the anticipated rater of return, the lower the anticipated liability and vice versa. The incentive problems don’t stop with lawmakers who like to arbitrage political reward from cost. Pension fund managers themselves have a strong incentive to make the liabilities look smaller than they are with a higher discount rate. That is a higher expected rate of return. So what can they do? They can hire consultants who will help them achieve that end. And if taxpayers are on the line for any failure to make adequate returns, that pushes managers to make risky bets with taxpayers’ money in hopes of achieving high returns with little risk.

But Riordan and Rubalcava don’t want the feds to merely bail out state pensions. No no no. They want the feds to only bail out state pensions that make significant changes to their structure, the most important of which is switching all new hires to 401k-style plans that limit the state liability and fix the mismatch problem between promises and payments. They analogize it to the Race to the Top money for education bureaucracies.

Let’s take that comparison seriously. Wasn’t Race to the Top just a handout to state Big Ed in exchange for, not implementing reform, but merely removing impediments to reform? That’s not really the same thing as requiring the implementation of change before providing funds, which is precisely the problem with a federal solution to growing pension liabilities. Any federal solution is unlikely to look like what Riordan and Rubalcava want and could easily do very little to solve the underlying problem.

First, a federal bailout conditioned on switching every new-hire to a 401k is, at best, troubling to those who just want the state to get out of the retirement business as quickly as possible. Second, wouldn’t a credible pledge from the feds to never ever ever ever offer up a pension bailout do as much to get states to make much-needed reforms? Race to the Top demonstrates that the feds face the same public choice pressures that state lawmakers face. After all, Race to the Top didn’t really get states to actually do much of anything. Should we really believe that a federally designed solution to nudge state pensions in a particular direction will really be more effective than the very real threat lawmakers and taxpayers face: being forced to make gut-wrenching choices among paving highways, educating kids, public safety and paying pensioners?