Pension Reform a COLA Away

Something’s gotta give.

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That’s the message coming loud and clear from courtrooms, state houses and city halls from Detroit to Springfield, Ill., to Cranston, R.I.

In Detroit, a federal judge on Tuesday ruled that the city is broke and that the dire financial situation allows for equally dire solutions. Those solutions will likely include reductions to municipal pensions once thought untouchable because the retiree payouts are guaranteed under Michigan’s state constitution.

Meanwhile, state legislators in Illinois are mulling a deal that would plug a $100 billion hole in the state’s public employee pension fund. Illinois has the dubious distinction of digging the deepest pension fund hole of any state in the U.S. -- and that’s saying something.

In 2012, the Pew Research Center published a report filled with startling data related to the inability of nearly every state to cover its long-term public pension obligations. According to the report, a healthy state pension system should be at least 80% funded. In 2000 more than half the states’ pension funds were fully funded. But by 2010 just one state – Wisconsin -- was fully funded, and 34 had fallen below the 80% threshold.

There are reasons for this: public employee pension funds, like everyone else invested in the stock market five years ago, suffered heavy losses during the financial crisis. Add to that a soaring number of retirees receiving benefits each year as millions of baby-boomers reach quitting age, which can be relatively young -- late 40s, early 50s -- for many public employees, especially cops and firemen. 

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Tax Payer Revolt

“Though states have enough cash to cover retiree benefits in the short term, many of them – even with strong market returns – will not be able to keep up in the long-term without some combination of higher contributions from taxpayers and employees, deep benefit cuts, and, in some cases, changes in how retirement plans are structured and benefits are distributed,” the report concluded.

Given the mood across most of the country, any statewide proposal to raise taxes specifically to cover the rising cost of public employee pensions would surely lead to a taxpayer revolt, at the very least. So the only other alternative is changing how the plans are structured and the benefits paid out.

This is where the rest of the country could learn from Cranston, R.I., a bustling city of 80,000 just southwest of Providence.

Facing a budget shortfall that could have gutted public services and led to widespread layoffs, Cranston earlier this year announced an agreement on pension reform with retired police and firefighters. Under the renegotiated system, the pensioners agreed to suspend cost of living adjustments (COLAs) for every other year for 10 years, to reduce the COLA increase from 3% to 1.5% for the next two years and cap any future COLA increase at no more than 3%.

There are certainly more glamorous topics of conversation than COLA increases for retired public employees. But the fact is they stand at the root of an issue that has bubbled to the top of the national debate in recent years. At the crux of that debate is whether public employee retirement benefits are too generous, and whether taxpayers can continue to foot the bill for these packages for decades to come?

Gradual Changes to COLAs

The issue has become particularly heated as many private-sector companies, facing myriad economic headwinds, have scaled back contributions to their employees’ 401k retirement funds, which, obviously, are vastly different animals than the guaranteed, defined benefit packages (pensions) offered to most unionized public employees.

Since an outright shift to public 401k systems (known as defined contribution programs) seems unlikely – or politically impossible -- gradual changes to how public pensions are distributed, such as COLA adjustments, is a start in the right direction.

“Rhode Island did it right,” said John Tillman, chief executive of the Illinois Policy Institute, a conservative-leaning think tank.

According to Tillman, suspending or adjusting COLAs is the “single most identifiable solution” to long-term pension fund woes. In Illinois, suspending state retirees’ COLAs would very quickly cover one-third of the state’s unfunded liabilities, he said.

Furthermore, COLAs should not be compounded annually and they should be means tested. Specifically, retirees receiving $30,000 or less should get COLAs, by Tillman’s criteria. Any pension above that  wouldn’t be eligible for a COLA.

“That essentially solves the COLA problem,” he said.

Not Far Enough

The proposal now before Illinois legislators would keep COLAs at 3% compounded annually for a portion of a retirees’ pension benefit. That portion would be determined by multiplying a pensioner’s years of service by $1,000. So a 25-year employee would be eligible for COLA on $25,000 of his pension, no more.

Tillman said that doesn’t go far enough.

For instance, it still allows COLA increases for what Tillman angrily describes as millionaire pensioners, or that not-so-rare breed of former public employee who collects a mid-six figure pension and then gets a boost to that amount each year through a COLA.

Meanwhile, states like Michigan, Illinois and Rhode Island have to cut back services, lay off police, firemen and teachers, and delay or scale back infrastructure improvements, all while placing bigger tax burden on the middle-class to cover growing pension obligations. Sadly, in far too many cases those pension funds are going to people who don’t really need the money.

“The immorality of that will finally create change,” Tillman predicted.  

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