The pension liabilities that helped bankrupt Detroit have cast a harsh light on similar problems in Chicago and other American cities, adding urgency to the question of who should close the shortfall. This is a challenge that public-sector workers and retirees shouldn’t bear on their own.
The pension liabilities that helped bankrupt Detroit have cast a harsh light on similar problems in Chicago and other American cities, adding urgency to the question of who should close the shortfall. This is a challenge that public-sector workers and retirees shouldn’t bear on their own.
The pension problem is by now well-known. Detroit’s emergency manager estimates its unfunded liabilities at $3.5 billion, about a fifth of the city’s debt. As of last year, Chicago had funded just 36 percent of its pension obligations, while, as of 2011, Philadelphia had put aside just 50 percent.
States aren’t doing much better. Thirty-four states failed to make their required pension contributions last year, and nine set aside less than 60 percent of what’s needed. All told, state and municipal pensions are underfunded by at least $1 trillion.
The twin questions facing policy makers are how to fix the problem and how to apportion the cost among workers, retirees and taxpayers as a whole.
First, governments need to stop lying to themselves. Money that’s slated to cover pension and health care fund contributions but is instead siphoned away to cover other costs won’t magically reappear in later budgets. In the future, states and cities should agree only to benefit packages based on reasonable rates of return and payable annual contributions.
Many jurisdictions will also have to scale back their past promises. It may also require sacrifices by already retired workers.
A particularly thorny issue is the future of defined- benefit pensions, which most public sector workers enjoy but private employers have largely replaced with cheaper defined-contribution plans. Those benefits help governments compete with private employers, which may be able to offer higher wages. They also reflect the power of public-sector unions, which have mostly outlasted their private-sector counterparts.
If governments continue to provide defined-benefit plans, it should be under more stringent conditions, including conservative assumptions about rates of return, larger initial payments and protections against gaming the system. Or, they can scale back gradually to defined-contribution pensions by first adopting hybrid plans, that include 401(k)-style accounts.
No matter how gracefully such changes can be accomplished, it won’t be fair to expect workers and retirees to be the only ones to sacrifice. After all, they are not the people who set the unaffordable policies in the first place.
The lesson of Detroit is that states and cities can’t afford to ignore their obligations and waiting makes things worse.