Four Little-Understood Points on State Pension Problems

Fixing underfunded state and local pension programs is a long-term goal that most states can accomplish with moderate, common-sense steps.  A major report we released today outlines those steps. Here are highlights from the report:

• Today’s pension shortfalls were caused in substantial part by the 2001 recession and the recent Great Recession. Those recessions reduced the value of assets in pension trust funds and made it difficult for some jurisdictions to find sufficient revenues to make required deposits into the trust funds.  As a result, the average state pension fund is considered “underfunded,” meaning it has insufficient assets to pay 100 percent of the future retirement benefits that current state employees have earned, even taking into account the future investment earnings on those assets.
• Fully funding pension shortfalls immediately would be both difficult and unnecessary. State economies and budgets continue to struggle because of shrunken revenues and rising needs.  The long-term pension shortfalls are not the cause of the current state fiscal problems, and addressing them need not overwhelm state and local budgets right now (or reduce states’ ability to recruit and retain a high-quality workforce).  If states and localities over the next five years boost their pension contributions to roughly 5 percent of their budgets (compared with the present level of 3.8 percent), they can make major progress in restoring plans to full health.  If they also reduce benefits or increase employee contributions, the increases in state contributions can be smaller than would otherwise be necessary.
• Many states and localities are already taking steps to improve pension funding. Some 11 states last year increased employee contributions toward their future pension costs; 16 states made changes that will reduce benefits for future employees, such as changing the formula used to set pension levels or increasing retirement ages.  (Several states did both.)  In addition, a number of states reduced or eliminated cost-of-living increases in pension payments, primarily for future employees.  Other states have made changes that will facilitate more consistent and adequate funding for pensions.
• States and localities can strengthen their pensions without causing large problems for other parts of their budgets or their economies while the economies remain weak. States and localities should:
  • Act now to craft a plan that will restore pension trust funds to solvency gradually.  Most states and localities can defer large increases in pension contributions that would place significant additional pressure on their budgets for a few years until revenues have recovered more fully from the downturn.
  • Move carefully to change, as necessary, their methods for determining needed contributions.  Requiring much larger contributions now while state budgets are still in crisis would force states and localities to take even more money away from other areas of spending at a time when they are already cutting important services and investments.
  • Immediately change pension rules to reduce the potential for uncommon but damaging abuses such as “double-dipping” (where, for example, a person claims a public pension while continuing to draw a government salary) and “spiking” (where employees artificially inflate their final year’s earnings in order to boost their pensions).
  • Gradually address underfunded pensions with a balanced combination of adequate contributions to pension funds by governments and employees (in the states where employees are not already contributing adequately) and restructuring of benefits as appropriate.
  • Continue to offer defined-benefit plans, since to do otherwise would actually make it harder for states to restore fund balance.

These are general principles.  Any reform strategy must reflect an individual state’s circumstances, with radical changes reserved for the group of states whose pension plans are the most severely underfunded.