Transparency is the new watchword in government, but we continue to have a public pension system that puts obfuscation first.
Personally, I think we should pay the Commonwealth’s public servants more, not less. However, this payment should come in the form of current salary, not post-retirement benefits. Skewing compensation toward post-retirement benefits is bad for workers and bad for taxpayers, but it is inevitable as long as those benefits are less transparent than wages. By putting compensation into pensions and health benefits that are not transparent, local governments can look like they hold the line on salaries but still reward their workers.
The most natural way to fix this problem is for governments to follow the private sector out of defined-benefit plans and into defined-contribution plans akin to 401(k)s. The transparent nature of defined-contribution plans, in which employers pay regularly into workers’ retirement funds, reduces the incentive for governments and unions to skew compensation toward hard-to-measure post-retirement benefits.
Today, public employees have been promised almost $13 billion more in pension benefits than Massachusetts has set aside money to pay for. We owe another $13 billion for other post-retirement benefits to public workers. The average U.S. state funds 83% of its pension liability. The Commonwealth has funded only 73% of its debt, and a lot of cities of towns are in much worse shape. Quincy has funded only 58% of its pension liability; Springfield has funded less than half.
In any employment relationship, workers receive compensation in the form of salaries, pensions, and health benefits. Ideally, the tradeoff between these different forms of compensation reflects employer costs and employee desires. However, when firms are spending someone else’s money, then there is a strong tendency to load compensation toward non-transparent forms of payment.
In their heyday, Detroit’s Big Three automakers paid extraordinary benefits rather than salaries, so management could satisfy the shareholders by being tough on wages and still avoid being whipsawed by Walter Reuther and the United Auto Workers. Today, these firms are suffering from these debts. Our local governments have pensions that are too high and salaries that are too low, because everyone screams at the prospect of a public servant getting paid a decent wage, but no one who isn’t a CPA can figure out how much a benefits package is worth.
Why is this a problem? From the workers’ perspective, overloading pensions relative to salaries means that they are essentially lending money to municipal governments. That just makes no sense. Because much of their compensation comes only after decades of service, municipal workers have too little today to spend on housing, schooling, and food.
From the taxpayers’ perspective, the pension system’s unpredictability and lack of transparency means that cities and towns will continue to have regular fiscal crises when health and pension costs exceed expectations. Plus, the current system creates enormous incentives for people to game the system by pushing up their wages in their final years of service.
Moving to defined-contribution plans for new public employees would be a step in the right direction. In the private sector, defined-contribution plans are ubiquitous. They allow workers to move more readily across firms. They make payment more transparent and reduce the risks posed by unfunded liabilities. Defined-contribution plans for public employees would have the same benefits.
Contract negotiations would be restricted to the size of the employer’s contributions, and those payments would be transparent. This transparency would eliminate the artificial incentive to backload payment into pensions — a system that does no good for either taxpayers or our public servants.
Edward L. Glaeser, a professor of Economics at Harvard, is director of the Rappaport Institute for Greater Boston. He is a guest columnist for the Boston Globe, where this article first appeared.