A bill under consideration by the Michigan Legislature, House Bill 5726, would allow local governments to borrow money to cover unfunded liabilities in their defined benefit pension systems, but only if they close their plans to newly-hired employees (in most cases providing them instead with a 401(k)-type plan).
The goal of getting out of the defined benefit government pension benefit racket could not be more laudable, but there are problems with using this approach to do so.
These pension obligation bonds are supposed to allow governments to borrow at a low-rate interest and invest at a higher rate of return. The gains are used to pay for gaps in pension funding. The problem is that investment gains are not guaranteed but the interest on those bonds is. Taxpayers get whipsawed if investments don’t pan out.
It amounts to buying stocks on margin, an inherently risky proposition, but possibly worth doing if it helps more local governments place themselves on a glide path to gradually eliminating employee legacy costs.
As mentioned, governments across the state and country have underfunded these pension plans, placing taxpayers on the hook for what Andrew Biggs of the American Enterprise Institute estimated to be $4.6 trillion in unfunded liabilities.
Unfortunately, while House Bill 5726 requires that a local government close its defined benefit pension plan, it offers taxpayers no guarantee that the plans will stay closed. Indeed, short of a state constitutional amendment prohibiting governments at all levels from providing new employees with defined-benefit retirement benefits — a proposal with great merit — governments are free to abandon their commitment to a defined contribution system. That's because what a legislative majority and governor enact today could just as easily be un-enacted later by a different governor and legislature.
With that caution in mind, any pension bond bill should include language prohibiting a local government from re-opening a defined benefit pension system once it has been closed, or creating any new plans of this type.
Some local politicians, especially ones in communities approaching fiscal insolvency, are desperate for cash and ready to impose higher debt burdens on their residents. The reward of closing government pension systems may be worth the risk, but only if this potential loophole is closed in a convincing manner.