The average government employee receives a significantly annual higher compensation than the typical private sector employee – not because of wages, or even health insurance benefits, but rather, due to the size of public pension funds, according to a report recently released by The Heartland Institute.

But, as headlines across the nation affirm, governments can ill afford the pensions they have been promising their employees, exerting significant pressure on state and local government finances.

The unfunded collective liability – a measure of the shortfall between promised pension benefits and the ability of the pension fund to pay those benefits – is estimated to be between $750 billion and $1.75 trillion, says the report, entitled, The State Public Pension Crisis: a 50-State Report Card.

Some state public pension funds are faring better than others, according to the report. Alaska, Florida and North Carolina earned top positions in the rankings, while Hawaii, Louisiana and Kansas received the lowest marks.

In the interview that follows, Eli Lehrer, National Director of the Center on Finance, Insurance and Real Estate at The Heartland Institute and a co-author of the report, shares his insights on how the public pension situation has reached the crisis level, and the measures needed to reverse the trend.

MuniNet: For starters, why do state and local governments spend so much money on employee pension funds?

Lehrer: Pensions seem like a natural fit for government employment for at least three reasons. First, many government jobs – police officers and firefighters, for example – have few or no exact equivalents in the private sector and thus, individuals in those fields, even today, will often plan to spend their entire careers with one employer.

Second, unlike private employers, governments don’t go out of business and rarely even shrink. So as long as the tax base keeps increasing, governments can meet employee pension obligations.

Finally, in collective bargaining situations, which are increasingly common in the public sector, both political and union officials will often work together to increase pensions even when neither workers nor taxpayers particularly want an increase. Elected officials can avoid popularity-killing short-term tax increases if they promise employees more money in the form of future pension benefits and while union officials can still claim a “win” for the people they represent even if they cave on other issues.

The result of these factors has been an explosion in the size of public sector pensions even as private sector work patterns have tended to move employers and employees alike away from defined benefit pensions.

MuniNet: High compensation costs, including pensions, were a huge factor leading to Vallejo, California bankruptcy filing. Do you think the situation could reach similar proportions – and cause similar problems – for other governments, whether state or local?

Lehrer: Unless there’s a particularly strong economic recovery, more and more local governments will run into serious problems. Without widespread reform, it’s quite likely that we’ll see a fair number of cities and counties file for bankruptcy protection over the next decade.

[States are not eligible to file for any type of bankruptcy protection; however, they can repudiate their debt and/or run out of money to pay their bills, which could cause them to default or lose market access.] In these cases, infrastructure financing would become much, much more difficult.

MuniNet: California makes frequent headlines in the news due to its pension woes, yet in your report card, the state earns a “B” … how did it earn such a high mark?

Lehrer: Two reasons. First, the rating is based on 2008 data and California’s situation has worsened since then. California will probably get a lower grade when we do the survey again. Second and much more importantly, California’s pension problems are so serious mostly because the rest of its problems are so serious. The state constitution mandates a wide range of government programs and dictates how a lot of the budget will be spent. Caps on property taxes, furthermore, make it hard for the state government to turn any services over to local governments. The need for super-majorities for tax increases and a lousy bond rating make it almost impossible for California to either issue significantly more debt or raise taxes significantly. The bottom line: California’s pension system is a problem mostly because the state has so many other problems, not because the way it is constructed is intrinsically so problematic.

MuniNet: In constructing the framework for the report card and rankings, what factors did you take into account?

Lehrer: States were evaluated on the basis of six variables. They are:

  • employee contribution – the amount employees must contribute to their own pension relative to the taxpayer subsidy;
  • choice of retirement plan – whether employees have a choice of defined benefit or defined contribution plans;
  • taxable benefits – whether states tax public pension benefits as income when they are paid;
  • time before vesting – how many years workers must serve before they are entitled to pensions;
  • earnings basis for pensions – which years or how many years of earnings are used as the basis for determining the size of pensions; and
  • fund solvency – reported funds on hand as a percentage of expected liabilities, relative to other states.

Not all of these variables were weighted evenly, however. The variables most likely to affect taxpayers – size of the contributions made from tax dollars and the overall funding of the plan – were given greater weight than the others.

MuniNet: Would you say that the states at the top of the list – Alaska, Florida, and North Carolina, for example – that earned “A’s” run exemplary pension funds?

Lehrer: I wouldn’t say that the states at the top of the list are perfect in every way; in fact since we released the report, Florida has seen its pension balances drop below the full-funding level. In general, however, the state pension systems that earned “A’s” are pretty decent. Legislators and concerned citizens should pay careful attention to pension systems in all these states, as well as in others that earned lower marks.

MuniNet: Is this a reversible trend? Can the public pension fund “crisis” be turned around?

Lehrer: Yes, the pension crisis surely can be resolved. It will be surprisingly easy in some states, very difficult in others. But there are a few things all states should try to do.

First, states need to reserve defined benefit pensions for people who they were intended for: workers who spend the great bulk of their careers working for the government. Second, employees should pay their fair share. This means that benefits should be taxed on the same terms as other income, that employee contributions should, at minimum, be equal to taxpayer contributions, and that reasonably rare but extremely problematic incidents of “spiking” and “double dipping” should be ended. Finally, states need to take general steps to reign in public sector workforce compensation costs.

In my judgment, government pensions are not an intrinsically bad idea per se. They are a problem, in large part, because they serve as an element of compensation packages that, particularly for mediocre workers, are significantly better than those in the private sector. Governments around the country have to take a look at the overall issue of employee compensation and cut them back. Many governments wanting to retain talented employees, however, would be best off cutting other perquisites rather than pensions. Although I doubt that they will, government employees and their unions would do well to bow to reality and give up certain current benefits in return for efforts that secure the future of pension systems.

About the Expert:

Eli Lehrer is senior fellow at The Heartland Institute, where he directs the Center for Finance, Insurance, and Real Estate, with offices in Chicago, Washington, DC, Tallahassee, and Austin, addressing issues relating to insurance, risk, and credit markets.

Lehrer also played a major role in founding the coalition, a coalition of taxpayer, environmental, insurance, and free-market groups dedicated to risk-based insurance rates, mitigation, and environmental protection.

Prior to joining Heartland, Lehrer worked as speechwriter to United States Senate Majority Leader Bill Frist (R.-Tenn.). He has previously worked as a manager in the Unisys Corporation’s Homeland Security Practice, senior editor of The American Enterprise magazine, and as a fellow for The Heritage Foundation.

Lehrer holds a B.A. (cum laude) from Cornell University and an M.A. (with honors) from The Johns Hopkins University, where his Master’s thesis focused on the Federal Emergency Management Agency and flood insurance.