By Ron Knecht and Geoffrey Lawrence
Recently, we’ve been reflecting on our experiences over the past year of public service together and the lessons we’ve learned.
Many of those lessons are unique to the particular functions of the Controller’s Office and include managing the departments of the office. But we also made more topical observations about our experience and how it has helped to shape and refine our views.
Ron, who already had decades of public-sector experience in Illinois, California and Nevada, came to the office well versed in government bureaucracies, along with the inter-agency rivalries and interest-group politics that, unfortunately, often impede their efficient and effective operation. For Geoff, however, who spent the previous ten years in the think-tank realm, the experience has been eye-opening.
In particular, Geoff now understands the Public Employee Retirement System from an entirely new perspective. As two economists and numbers geeks, we have both independently voiced our criticisms over the years regarding the way PERS is structured. Essentially, that criticism boils down to two major points.
First, certain assumptions used by PERS and many other public-sector, defined-benefit pension plans around the country have not been updated to reflect foreseeable future economic conditions and have become quite unreasonable. Each year, PERS calculates the future retirement benefits that have already been earned by employees and discounts the future annual values to present-value terms in order to compare the system’s obligations to its current assets. Any gap in value is called an “unfunded liability.”
PERS discounts its obligations to present-value terms at a rate of eight percent annually, which reflects an expectation that system investments will yield that rate of return each year. That assumption may have been reasonable ten years ago and before when market returns were high, but our economy has changed significantly since then.
In the early 1980s, it was possible to earn more than ten percent interest simply by buying short-term federal bonds with very little risk. Today, however, those bonds yield only about 0.25 percent. Even more risky U.S. corporate bonds currently yield only about 5.5 percent and there’s no reason to believe their yields will increase significantly in the foreseeable future. So, PERS is significantly overstating its discount rate and thereby making the gap between assets and liabilities look smaller than it really is.
Each year PERS fails to achieve an eight percent investment return, it has to recognize a larger unfunded liability thereafter.
This leads to the second criticism. By understating the true gap for a number of years, the full cost of financing future benefits is pushed further and further out onto future taxpayers and employees. When returns fall short and the recognized unfunded liability grows, PERS actuaries adjust upward the required annual contribution rates from employers and employees to make up the difference.
So, when Geoff’s beautiful bride asked him recently whether he, as a public employee, ever receives annual raises, he replied that he just received a 1.0 percent increase last summer, but that it was entirely offset by a required increase in the portion of PERS contributions withheld from his paycheck.
Over the past 30 years, required contributions have roughly doubled, from 15 percent of pay to 28 percent of pay. This amount is split between public employees and taxpayers, who, as the employer, match the employee’s contribution on a 50-50 basis.
(At the local level, many unions have gotten county and municipal leaders to make the entire contribution, including the employee portion. We proposed last year to balance the state budget without tax increases greatly by making local employees pay just a quarter of the required contribution, with taxpayers matching three dollars to every one dollar paid by city and county employees.)
The continuing increases in required PERS contributions, as we’ve both understood for years, is a bad deal for present and future taxpayers who must pay more each year because the true costs of past promises were underestimated. However, it winds up also being a bad deal for state employees because the take-home portion of employee compensation is diminished over time to provide benefits for previous generations.
So it’s from both perspectives now that we support a shift to a defined-contribution retirement plan where costs are fixed and predictable.
Ron Knecht is Nevada Controller. Geoffrey Lawrence is Assistant Controller.