David R. Henderson  

McChesney on Government Pensions

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In some areas, the system works in a blatantly self-interested way. Take Baltimore, where the police and firemen pension board recently passed a pension increase that, according to the Baltimore Sun, was "whopping," due to "[h]eavy stock market losses." The city allows policemen and firemen to retire after 20 years, with a pension equal to 50 percent of their salary. So a public employee can retire at age 40, work elsewhere and draw a pension. Even "better," the city gives retired employees a permanent pension increase when the city's retirement fund annual performance exceeds a certain percentage, but does not reduce pension payments when the fund loses money--as, of course, it has in the past two years, just as practically every investment fund has. And "best" of all, the Baltimore pension fund is run by those receiving pensions. Its chairman is also the head of the city's firefighters union.

This is from Northwestern University law professor Fred McChesney's Econlib article, "Government Pensions: Such a Deal," posted today.

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CATEGORIES: Labor Market

COMMENTS (3 to date)
Boonton writes:

I think the problem here is a poor incentive that hits both the public and private sector. Pensions are promises to pay far in the future. In theory, employers (gov't or business) should treat a pension increase as a wage increase. More cash is needed today in order to set aside a savings fund large enough to pay the pension tomorrow. In both cases, though, complications intervene. Tomorrow is a long ways off, the people running things tomorrow will be different. If the contribution is cut just a little bit today, there's a good chance no one will notice since market variations alone can make a pension fund swing wildly between under and over funded....

I proposed an idea on my blog to create a standardized, small pension unit. For an amount of around $100, anyone can purchase a 'pension unit' which issue an annuity starting at retirement. The pension unit would be like a US savings bond in that it is small enough to buy as a trivial gift but could be accumulated to become a serious portion of someone's retirement portfolio.

By purchasing pensions from a 3rd party, governments and businesses would have to be transparant in accounting for their obligations. If the police union negotiates a nicer retirement, the state has to purchase more $100 'pension units' right now. Likewise individuals could purchase pension units for themselves if they want less 'lump sum 401K' and more social security like annuity in their retirement.

floccina writes:

Because of this sort of thing Government jobs are very desirable and draw employees away from jobs in which they might produce more.

Paul Jenssen writes:

While I don't disagree that investment losses will have to be made up with higher taxes, I believe Mr. McChesney is missing a critical point.

Most private plans are defined contribution. If investments decline the employee loses.

Many government plans are defined benefit. The government has an obligation to pay the employee $X/year upon retirement. If investments decline, taxpayers have to make up the difference with increased funding from higher taxes.

This is going to become a huge issue as taxpayers start to realize how expensive government pensions really are. Another annoying fact is that the higher cost of government pensions are rarely included when journalists compare private and government salaries.

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