There is only one pension issue

The problem with government pensions boils down to a simple issue: The state promises something now, but pays for it later.

It is a matter of basic fairness — taxpayers should pay for services when those services are given. The Michigan Constitution requires it, and for good reason. As a state constitutional delegate warned when the current constitution was being developed, “Any public [pension] system that is set up should have put into it each year sufficient money to meet all of the liability accrued during that year ... but when you go for years without putting in enough money to cover the liability accruing each year, then trying to catch up for the past deficiency becomes a problem of magnitude.”

That provision was put in place over 50 years ago, and Michigan finds itself in the same situation it tried to prevent, owing retirees billions for a “past deficiency.”

In order to pay government employees the pensions they’ve earned, pension fund managers have to make assumptions about what will happen in the future. If they are too optimistic, then pension plans develop unfunded liabilities — in other words, the government has promised more than it has saved for.

Politics often gets in the way of proper pension management. There are few political advantages to a well-funded pension system. Politicians benefit more by spending money on current programs that electors see, like schools, roads and welfare. Socking money away to improve a pension system’s solvency excites hardly anyone.

That is why it is rare for governments to have saved enough to pay for what has been promised their employees. There is $26.7 billion owed to people in the school retirement system, $5.8 billion owed in the state system and $5.5 billion owed in a large local government system. And those figures are based on the plan’s own assumptions — assumptions that contributed to the underfunding in the first place.

This is the essential issue facing pensions in Michigan. Yet lawmakers are often distracted from the issue when considering reforms. A Senate committee considered a bill to offer new employees in the school retirement services defined-contribution benefits on Wednesday. This system would give employees up-to 7 percent of their payroll into a retirement account that they control, meaning that the state’s promises are met when an employee works and not deferred to the future.

Unfortunately, the state’s office of retirement services fabricated an analysis telling lawmakers that this would generate hundreds of millions of extra costs to pay down the existing unfunded liabilities in the system. But such funding decisions are fundamentally up to policymakers. And one of the costs raised by the state were explicitly avoided in the legislation they were considering.

Moreover, there is a bit of irony in getting lecture on fiscal prudence from the people that accidentally made school employees the state’s largest creditors.

Lawmakers shouldn’t let such claims stop them from approving this plan. Governments can help employees save for retirement by providing matching contributions to retirement accounts owned by the workers themselves. It’s better for both employees and taxpayers when retirement benefits are paid when they are earned. This reform will finally contain Michigan politicians and pension fund managers from continuing to dig a deeper fiscal hole that taxpayers will eventually have to fill.

James Hohman is the assistant director of fiscal policy at the Mackinac Center for Public Policy.