Originally posted at the San Francisco Chronicle.
By Dr. Keith Naughton.
While the bankruptcy of Detroit gets national media attention, the true ground zero for the fight over public pensions is playing out in San Jose.
Unlike Detroit, San Jose is not an economic basket case. It has no vast stretches of urban wasteland. There is no impossible operating deficit or former mayor jailed for corruption. The fact that an economically stable city like San Jose is forced to renegotiate its obligations is the first sign that hundreds of other communities across the country simply cannot and will not fulfill their future pension obligations.
If you are a state or local government worker, you should be preparing yourself for a much lower retirement payout than you were promised. If San Jose is staring at default, trouble is not far from other communities.
Laying blame for America’s municipal pension mess is like figuring out who the murderer is on the Orient Express. Everybody did it.
Politicians made promises they knew they wouldn’t have to keep. Union leaders bargained for every last dollar, regardless of whether cities could pay up. Bond buyers took an extra slice of interest while whistling past the graveyard. And voters weren’t paying attention at all.
The end result is that the defined-benefit pension is proving to be anything but for a growing number of retirees.
The heart of the problem is pure politics. The politicians who negotiated the pensions were concerned with re-election, not with the bill that would come due. It was easy for them to make promises for payments 20 years down the road when they knew they would not be in office and responsible for those promises.
Overpromising was only the first step. When faced with rising costs, these same politicians could either cut services or raise taxes. They chose the third option: cook the books.
Today, the political calculus has changed.
With pension funds going broke, politicians have nothing but bad choices. They can raise taxes, cut services to the bone, or walk out on the pension obligations. Because pensioners are a small voting bloc compared with taxpayers, the pensioners are going to lose.
There really is no such thing as a defined-benefit pension. The defined-benefit guarantee is going to founder on the rocks of political reality. While public employee pensions are not going to zero, they will fall.
Relying on the promises of politicians is a risky game, but relying on future politicians to keep the unrealistic promises of past politicians is a losing game. There is certainly no evidence politicians are evolving toward keeping their promises. If anything, they are evolving toward more creative ways of denying economic reality.
Yet municipal workers and their unions are failing to learn from this debacle.
As great as defined-benefit pensions sound, the fact is that those defined benefits are only as secure as the finances and political will of the future. There is no reason to believe that the politicians of today or tomorrow will act more responsibly than the politicians of the past.
Labor unions and their members, who are relying on state constitutional guarantees they will be paid, are just fooling themselves. San Bernardino already is simply refusing to pay into the California pension system. When the political pain becomes intolerable, the politicians will change the rules.
The smart strategy would be for workers to shift to defined-contribution plans under their personal control. Because the contributions by the local government will be defined and due each year, politicians (today’s and tomorrow’s) will not be able to cheat the pension fund with accounting tricks and unrealistic assumptions. Even if a city goes bankrupt, the workers will have something.
The benefits that municipal workers have been counting on are turning out to be a mirage. The best thing for them is to walk away from the defined-benefit fantasy and take control of their own retirement funds.
Cooking the books
The recipe: If a city needs $100 million to meet pension liabilities in 20 years, it will have to set aside just over $2.5 million per year and achieve a conservative 6 percent annual rate of return.
Secret sauce: But if a city assumes an 8.5 percent annual rate of return, it can cut that yearly payment by more than $600,000 to $1.9 million.
Culinary disaster: Assuming an 8.5 percent return is simply absurd, however political history shows that financial chicanery beats tax increases and service cuts any day of the week.
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Keith Naughton is a former political consultant and just completed a doctorate in public policy at the University of Southern California this past November.