Economic Opportunity

Straight talk about pension reform

The costs of servicing pension debt add billions to state budgets every year, crowd out other public services like education and transportation, and have major implications for long-term employee compensation. We learn from Leonard Gilroy at Reason Foundation.

May 27, 2021

The Charles Koch Institute is honored to work with innovative, thoughtful social entrepreneurs in education, business, communities, and government. In 2021, we’re asking some of our partners to answer a “big question,” to dream with us about a society of mutual benefit, where others succeed by helping others improve their lives. Today’s installment is with Leonard Gilroy, vice president of government reform at Reason Foundation and senior managing director of Reason’s Pension Integrity Project.  

CKI: Pension reform is difficult to understand. And tricky to talk about. Why? 

Gilroy:  

Pension reform is a difficult technical issue rooted in risk and the fuzziness of actuarial math that hits close to home for the workers involved. The situation is also on a slow burn — public pension problems slowly squeeze governments and add debt, but don’t usually create an immediate cash crisis. Politically, the long-term solutions are more expensive in the near-term than doing nothing. If you are fortunate to go the distance and pass good pension reforms, stakeholders and taxpayers may not see real cost savings for 10 to 20 years. Reform involves difficult stakeholder negotiations with real trade-offs — lawmakers know there’s little prospect for immediate political plaudits and a lot of hand-wringing from critics.  

Sounds like a great policy issue, right?! It takes a unique leader to take on the short-term political risks and champion much-needed reforms that protect future generations of taxpayers and workers.  

But the costs of servicing pension debt add billions to state budgets every year, crowd out other public services like education and transportation, and have major implications for long-term employee compensation. If the costs of the Department of the Past are rising, so to speak, then it will affect the Departments of the Present and Future. 

The effects are real. Over the past two decades, overall employer contributions to public pension systems in the U.S. have roughly tripled as a share of payroll, largely the result of servicing growing pension debt.  

For example, a recent study in California found that K-12 school district spending for employee pension costs more than tripled between 2013 and 2020, from approximately $500 per pupil up to $1,600 per student in 2020. School district administrators report that unfunded pension costs are forcing schools to curb enrichment programs and mental-health services, as well as decrease services provided to low-income students, English learners, and other high-need populations.  

This challenge is widespread across state and local governments. Policymakers often avoid true pension reforms, and instead scramble to address escalating costs by raising taxes, shifting money from reducing services, or — in the worst outcome for taxpayers and employees alike — a combination of the two. 

The good news is that over the last decade an increasing number of leaders are rising to the moment despite the unsung nature of their efforts. Some states like Oklahoma and Pennsylvania have shifted newly hired public employees to more sustainable defined contribution or hybrid retirement plans, while other states like South Carolina and North Carolina have made notable pension-funding policy improvements in recent years. States like Michigan, Arizona, Pennsylvania, and Colorado have shifted away from one-size-fits-all plan designs to an expanded retirement option set that is better suited to today’s government workforce. 

At the Pension Integrity Project at Reason Foundation we offer pro-bono policy design consulting, technical assistance, and modeling to help elected officials design and implement public pension reforms. We’ve been fortunate to provide technical assistance on the bipartisan pension reform efforts in many of these states since 2015. While every pension situation is unique and requires a tailored solution, we’ve found there are typically three critical ingredients to advancing productive pension reform discussions: 

(1) Be willing to spend now to save taxpayers more long-term: Pensions didn’t get underfunded in recent decades because they received too much money, but rather too little. Many of today’s pension problems stem from overly optimistic investment return expectations that add debt, or from governments failing to make needed contributions to fully fund promised benefits. Thus, pension systems will generally need more money in the near-term, not less, to work their way toward financial sustainability.  

Higher short-term costs typically yield lower long-term costs for pension plans. A recent Pension Integrity Project analysis found that a one-time $300 million surplus payment to Arizona’s public-safety pension system would yield up to $500 million in taxpayer savings over the next 30 years. 

(2) Pension underfunding is a complex publicpolicy math problem, so focus on technical  not politica solutions: Pensions are complex mathematical systems with many moving parts, and simple proposed fixes rooted in politics or ideology rarely solve the full problem.  

(3) Embrace compromise and stakeholder engagement: Pensions are utterly technical and confusing for many leaders and participants alike, but they also have an emotional component. The underlying issue involves retirement security and lifetime income in our most vulnerable adult years. Lasting pension reforms tend to be those that involve stakeholders deeply in the process and work past complexity and emotion. Recent pension reform successes in both Arizona and New Mexico highlight the value of collaboration and compromise in pursuit of reducing taxpayers’ long-term financial risk exposure and keeping promises made to workers. 

Public pensions may be technical and boring, but with well over $1 trillion in aggregate unfunded pension liabilities, state and local governments cannot afford to hold out hope that things will fix themselves. This year is likely to be a good one in the markets, and pension systems will no doubt trumpet good investment returns. But one-time positives cannot overcome two decades of declining pension health and do not obviate the need for reform in many systems.  

Luckily, a number of forward-thinking states have begun to embrace smart and holistic approaches to pension reform, creating models for others to adapt in pursuit of de-risking current pension systems, shielding taxpayers from ever-rising costs, and putting in place financially sustainable public-employee retirement plans for the future. 

Leonard Gilroy is Vice President of Government Reform at Reason Foundation and Senior Managing Director of the Pension Integrity Project at Reason Foundation.  

The Charles Koch Institute inspires and invests in social entrepreneurs developing solutions to America’s most pressing problems. Read more about our support for social entrepreneurs committed to economic opportunity.