Thursday September 10, 2015
The most sensible and fair way to move forward is to offer defined-contribution plans to new hires, and to stretch out the payments on the existing plans.
Houston’s pension problems are crippling city government finances, and the recent debt downgrade from Moody’s Investor Service is yet another reminder that our future depends on finding a solution. Notwithstanding the mind-numbing complexity of the city’s pension issues, the path out of it is fairly clear and can be summed up by two well-worn adages:
1. When you are in a hole, stop digging.
2. Keep your word.
The Hole We’re In
In just over a decade, irresponsible promises by politicians have taken the City of Houston from a pension surplus to a projected shortfall of more than $5 billion by 2020. With the city government in such a deep financial hole, the most important thing the next mayor must do is to stop digging. We cannot continue making promises to city employees that City Hall cannot keep, and which employees and beneficiaries will never receive.
The fairest way to do that is by migrating new employees — not current employees and beneficiaries, but new employees hired after an as-yet determined date in the future — to 401K-tyke defined contribution plans. This, by itself, does not solve the problem. But it does, at least, keep it from getting worse.
The private sector began making the switch to 401k-style defined-contribution plans 20 years ago. Today, a defined-benefit plan is almost unheard-of in the private sector.
There are those who argue that Houston will not be able to recruit qualified employees without a defined-benefit plan. There is scant evidence to support that view. For example, senior management officials at the Houston Police Department told me the higher starting pay and sign-up bonuses were a much more significant factor in boosting recruiting at HPD. In fact, at a May 28, 2015 City Council budget workshop, Chief McClelland said:
“This is what applicants tell me: they don’t look at long-term benefits. They look at who is offering the highest paying benefits right now. That’s what they gravitate to. That ‘If I’m going to risk my life doing this dangerous profession, I want to get the maximum benefits I can up front.’And that’s what they do.”
The reality is that many municipalities and other public entities recruit employees without offering defined-benefit plans. For example, the Texas Municipal Retirement System, which covers about 140,000 employees throughout the state, is a money-purchase retirement plan, which is sort of a hybrid between a defined-benefit and a 401k-style plan.
There’s a reason many politicians love the old-school defined-benefit plans: it allows them to collect kudos for raising benefits, but they don’t actually have to figure out how to pay for the benefits, because the bill doesn’t come due until years after they leave office. The next Mayor of Houston is going to inherit a maxed-out credit card from the irresponsible spending sprees of past administrations.
Anyone who proposes pension reform that does not ultimately wean the city off of defined-benefit plans is not serious about solving this problem. Defined-benefit plans are a device politicians can use to borrow money without going to the voters for approval. Regardless of how meager the benefits are, elected officials will never fully fund them.
Keeping Our Promises
But even if we stop digging, that does not fill the $3.7 billion hole we have now.
There are those who advocate changing the retirement system for existing employees. Some have even gone so far as to suggest that we claw back benefits because of some abuses, as I noted in previous columns. Certainly in the private sector, existing employees have frequently been transitioned from defined-benefit to defined-contribution plans in mid-career.
I believe that, in Texas, a deal is still a deal. Even if you believe that the city and the Texas Legislature made bad deals for the taxpayers when they agreed to the terms of the current pension plans, they nonetheless were the deals made by our duly elected representatives. If we do not like the deals they are making for us, then that is an issue to take up at the ballot box. It is not justification for reneging on the deals they made.
So what do we do about the $3.7 billion hole? We extend the payments.
Houston has the great fortune of a strong economy, which is likely to continue for some time. We have the luxury of borrowing this money at very low rates and spreading out the shortfall over a longer term. It is not an ideal solution, but if we try to continue making the payments as scheduled, we will either need to significantly raise property taxes or severely cut back city services — and we will not be able to make the infrastructure investments the city will need if it is going to continue to grow.
Other reforms can increase the effectiveness of our pension spending while improving the level of service to pensioners: for instance, I also think employees should have the right to opt out of the pension plans at a discounted cash value. Many city employees have told me they would prefer to have control over their retirement accounts.
Who would oppose a plan to stop offering city employees defined-contribution benefits? Taxpayers should favor it because it starts fixing the city’s biggest problem while dramatically reducing any budgetary pressure for service cuts and the like. Existing employees and beneficiaries should also favor moving NEW city employees to defined contribution plans because it means they will actually receive the benefits they were promised.
The one group that will not like it is the cottage industry that has developed around these pension plans. Last year, the plans doled out $54 million in salaries to pension plan executives, Wall Street investment bankers, lawyers, lobbyists, accountants and actuaries. They will come up with every reason you can imagine to keep the city on the path to financial ruin so that they can keep their noses in the pension trough.
President Ronald Reagan once said, "There are no easy answers, but there are simple answers. We must have the courage to do what we know is morally right." Continuing to make retirement promises that are not sustainable is not morally right. And it is irresponsible for future taxpayers and future municipal employees. We have all the tools we need to solve this problem, and once we do, we can finally begin to focus our efforts and resources making smart investments in our shared future.