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Commentary: State Budget Windfall Invalidates Pension Reform Excuses

Legislators should use extra money to shift new school employees to 401(k)-type accounts

According to the latest official projections, in the current fiscal year Michigan’s state government will collect $483 million more from taxes and fees than previously expected, and $219 million more next fiscal year.

Not surprisingly this has the usual spending interests lobbying intensely to get more for themselves. Yet despite today’s budgetary fair weather, storm clouds still darken Michigan’s fiscal horizon. In particular, huge unfunded liabilities in the school pension system. The temporary revenue windfall is an opportunity to ease this burden.

There is a $22.4 billion gap between the school pension system’s future commitments to retirees and the amount set aside to pay for them. This does not include health insurance benefits that school retirees have been collecting, but which in fact the state has no legal obligation to provide. (Like the rest of us, government and school retirees are all eligible for federal Medicare benefits at age 65.)

Why the gap? In the simplest terms, politicians cannot be trusted to adequately pre-fund a conventional defined-benefit pension system. Every state and practically every local government in the country faces pension fund shortfalls. In Michigan, not even strong language in the state constitution has been sufficient to break the vicious cycle of current lawmakers underfunding benefits promised to government and school employees.

It happens because politicians and pension bureaucrats can’t resist exploiting uncertainty about the future by adopting excessively optimistic payroll and pension fund growth assumptions. Overestimating the size of future payrolls or the rate of growth in pension fund investments depresses the expected costs today, but only at the expense of future taxpayers.

Michigan legislators know this, and last year they tried to fix the problem — and failed. Reforms were adopted that slightly reduced retiree benefits, but with the exception of the (optional) health coverage, over-generous benefits were never the real problem. It is instead the systematic failure to properly pre-fund those benefits, however rich or stingy they may be.

This institutionalized failure is what makes a “defined-contribution” retirement system — individual, employer-sponsored retirement accounts for employees — so superior. With such 401(k) and similar plans, legislators can’t promise something today and leave the burden of paying for it to their successors and future taxpayers.

Last summer, the state Senate actually voted to adopt this superior system for new school employees. Sadly, the House dropped the ball, instead embracing the false claims of pension bureaucrats and the teachers' union that so-called “transition costs” made this reform prohibitively expensive. Those special interests found it to their benefit to promote a misinterpretation of an accounting rule

That was then, but now — surprise! — a large and temporary budget windfall largely eliminates this excuse to not adopt what would be a genuinely transformational reform. (Paying more upfront will reduce the underfunding problem, anyway.) By no longer enrolling new school employees in the broken defined-benefit system, Michigan could be among the very first states in the union to put itself on a glide path to gradually eliminating the most onerous government employee legacy costs.

A 1996 reform gave us a head start by putting all new state employees into a sustainable 401(k) system, in the process preserving taxpayers from an additional $2.3 billion to $4.3 billion in unfunded liabilities. Doing the same today for the far larger school workforce would contain the politicians’ propensity to impose even greater unfunded liabilities on future taxpayers.

To the extent the false “transition costs” claim ever had any validity, this year’s budget windfall eliminates it as excuse to once again delay real reform. If not now, when? 

Michigan Capitol Confidential is the news source produced by the Mackinac Center for Public Policy. Michigan Capitol Confidential reports with a free-market news perspective.