Taking the Pension Task Force to Task

There is a well-established pension funding principle that was missing from the recently published report of the Responsible Retirement Reform for Local Government Task Force. The principle is that governments should pay for the promises they make to employees as they make them. This means that governments should set aside enough money each year to cover the full costs of the pension benefits earned by their employees that year. This prevents pension debt from growing out of control.

Yet this remains the fundamental challenge for financing pension systems. To keep them from becoming a burden on future taxpayers, pension managers need to accurately estimate their costs. This requires assumptions about what is going to happen in the future. If pension managers use overly optimistic assumptions, governments will not set aside enough money to pay for those promises.

The task force’s report focuses on the pension debt that Michigan local governments have already developed. There is a lot of it. The report lists $7.5 billion in pension debt liability and another $10.1 billion represented by current retiree health care policies.

Task force members did not make recommendations for how to pay down these obligations, but there are only a handful of options. Local governments can look for savings in their operations and put that extra money into the retirement system. They can cut retiree health care benefits. They can raise taxes and put that money into their retirement system. Or they can ask for more money from state taxpayers.

Instead, the report recommends that the state set up an entity to monitor local government pension systems and provide recommendations and technical assistance to help local governments. Local governments would report information on their pension systems to a new board, which would identify funding problems, provide oversight and create a plan for local governments to address these issues. Task force members were not unified in whether the new board should have the power to mandate changes to local government finances.

This seems to just be a different application of the state’s current insolvency-prevention policies. Local governments are required to balance their budgets and submit “deficit elimination plans” if they overspend. The state already monitors and assists local governments when possible. And if problems continue, the state has processes in place to get more involved. Though the emphasis is different, a lot of what the task force is proposing is already policy.

There was some good news listed by the report, however. Not every government has a pension problem. Of the 1,800 different general purpose governments, only 519 have pension plans and even fewer offer retiree health care benefits. But nearly all of the larger municipal governments do and nearly all are underfunded, as previous Mackinac Center research has shown.

Despite the criticisms above, there’s nothing wrong with the task force’s recommendations. Local governments are going to face challenges for underfunding their pension systems. But the task force should have reiterated that this is a problem that should never have happened and recommended ways for local governments to stop generating more debt.

Governments must take bold action to contain their ability to generate more pension debt, such as closing pension systems and offering new employees only defined contribution retirement benefits. That’s similar to what the state just did to deal with the massively underfunded school retirement system.