Since the right wing of Kansas’ Republican party gained control over the state government last month (defeating both Democrats and moderate Republicans to establish perhaps the most pro-Tea Party state government anywhere in the United States), we’ve been keeping an eye on developments there that could tell us what Tea Party governance would look like.
A new proposal on state pensions from the Kansas Chamber of Commerce offers a clue: the proposal would substitute defined contribution plans for the current defined benefit plan that goes to state retirees. For those of you not fully up on pension minutiae, this matters. In a defined benefit program, your employer promises a fixed stream of payments (usually with cost of living adjustments to take care of inflation) to employees when they retire. The amount of your payment is based on a formula that looks at things like your length of service and your pre-retirement pay.
This used to be the standard pension system in the private economy as well as for government workers. It is a very “blue model” system: it assumes a world of lifetime employment and stable employers. Often, defined benefit pensions emerged from negotiations between unions and employers.
In the private economy, the defined benefit system is in rapid retreat. Employers don’t like these pensions because they are both risky and expensive to manage. If the investments set aside to pay future pension obligations don’t perform well enough, companies have to divert current earnings to them or, worse, borrow money to make up the gap. Another problem with these pensions is that they create problems for companies facing fast technological change. Automakers, for example, need many fewer workers today than they did thirty years ago to produce cars; as a result the proportion of pensioners to active workers has shot up, and companies are stuck with legacy labor costs which make it more difficult for them to compete or attract new capital. Lengthening lifespans are also a problem; one of the risks companies bear under this system is that workers may live much longer than expected, turning a projected 15 year retirement into a 30 year post working lifespan. That is a very good thing in itself, but it’s a problem for a company trying to balance its books.
Employee calculations are also changing. While defined benefit pensions offer some security and predictability, most workers now expect to change jobs many times during a career. Job hoppers can get seriously penalized in a defined benefit system built around the needs of workers who plan to stick with one company for their whole career. It’s also become clear that these defined benefit plans are riskier than they look; today’s tumultuous economy means that many companies are at risk of bankruptcy, and when the company from which you’ve retired goes broke, your pension is anything but secure.
The alternative pension system that has gradually grown up to replace the old one with many private employers is called a defined contribution system. The amount you and your employer pay into the fund (in for-profit companies this is usually known as a 401(k)) is defined; the amount you get in retirement is based on how your investments do.
The new system on balance works better for most employers and employees in the private sector. While employees face the risk that their retirement funds may not grow as much as hoped, or could shrink in a big crash, these pensions are portable. You don’t lose your benefits when you transfer from one employer to another. You bear investment risk, but you are protected from the risk that your old employer goes bankrupt. And you have a fairly clear idea how much your investments are worth at any point so you can make your decision about when and how to retire based on a pretty good assessment of what your situation is.
State and government employees have by and large been untouched in the Great Pension Shift. Government workers tend to be lifers more than workers in the private labor force and governments (until recently) didn’t pose much of a bankruptcy risk, so the predictability and security of defined benefit pensions works on average better for government workers than for people in the private sector. Additionally, as we’ve noted before in VM, government pension programs are often quite generous. It’s easier for politicians to promise large pension benefits to be paid later than to raise wages for which money must be found today. Thus over the years unions and politicians have collaborated to raise worker expectations about future pensions—without necessarily making the financial provisions that ensure these pensions will actually be paid.
For these reasons and others, Kansas public unions are going to cry bloody murder if and as this pension bill moves toward passage. Via Meadia isn’t a card carrying Tea Partier and there are a lot of Tea Party ideas that give us pause. A lot of pause. However, we agree with the Kansas Chamber of Commerce that the switch to a defined contribution program makes sense—provided the program offers low and moderate income workers a reasonable path to an appropriate and secure retirement.
We particularly think this matters when it comes to teacher retirement. The truth is that many teachers should not be lifers. Some teachers age like fine wines, becoming more experienced, more professional, more engaged with each year in the classroom. At sixty or seventy they can engage their students better than bright eyed college grads still wet behind the ears. These teachers are national treasures and it is to them we need to look for the guidance, examples and leadership that young teachers need. But for many others in the field, what started as a vocation turns into a chore. Teaching is routine, dull, and they are tired of dealing with their students.
Unfortunately, the blue model system that offers lifetime tenure—and heavily penalizes people who switch fields—actively works to keep people in the classroom who should be moving on. The threat that losing your job also means losing some or all of your pension rights is one reason that teachers and teacher unions fight so hard against dismissals. Shifting to a defined contribution system that lets midcareer people leave teaching (or other forms of government service) for other fields without paying a pension price is an important government reform that helps everybody involved.
Some people will call the Kansas legislature radical if it transitions to a defined contribution system. Via Meadia will disagree. This isn’t radicalism; it is sound common sense.
[Image courtesy Shutterstock.]