In January, Gov. Bevin announced he would call a special session this year on pensions and tax reform. At the time, he said the issues must go together and rightly asserted tax changes could not be “revenue neutral” — meaning they must generate new dollars to meet our ongoing obligations.
In recent interviews, however, the governor has seemingly backed away from presenting a plan to raise revenue for a legislative session on pensions, calling tax reform a “totally separate issue.” But holding a special session on pensions without putting new money on the table would fail to address the problem we now face — and potentially make it even worse.
We’ve tried the pension reform “cure“ before with legislation overhauling and cutting future benefits, even as recently as 2008 and 2013. Those alterations didn’t make a dent in the unfunded pension liability — a problem from the past that cannot be resolved on the backs of those moving forward.
As the state’s consultant has shown, 76 percent of the unfunded liability in the state’s most depleted plan (the Kentucky Employees Retirement System non-hazardous plan) is for already retired or inactive members and 24 percent is for current workers on their way to retirement. In both cases, the commonwealth has a legal and moral duty to protect those benefits. Workers and retirees made life decisions expecting their already-modest benefits to be there, and we cannot go back on our word.
At the same time, new workers do not increase the unfunded liability — which by definition refers to benefits earned in prior years. However, new employees have been the focus of previous rounds of cuts because their benefits are easily changed under law — and because future workers don’t exist yet to put up a fight. Changing the structure of benefits again for new employees may actually add costs instead of reducing them.
For example, closing the current pension systems for new workers and switching to 401k-type defined contribution plans will make it much more expensive to pay down the existing plans’ liabilities. That’s because the portfolios in those plans will no longer be balanced by workers of different ages, requiring a shift to more conservative investments. That will reduce returns, resulting in substantially bigger state contributions to pay the liabilities off.
What’s more, the major problem facing the precarious KERS non-hazardous plan is a need for extra cash now and over the next few budgets. If the plan is closed to new participants, dollars contributed from and on behalf of new workers will no longer go into it, tightening cash flow further and putting the plan at greater risk.
A switch to 401ks for new workers will not even save money far down the road because the cost of Kentucky’s existing plans are already modest, and are on par with contributions made by private employers to 401ks and Social Security for their employees. It’s difficult to save money from defined contribution plans because they are a far less efficient way to provide retirement income. They deliver benefits 30 to 48 percent smaller for the same amount of up-front payments as defined benefit plans. That’s due to lower investment returns and the extra cost of annuities workers would need for the same protection from running out of money in retirement.
Inferior 401ks also lead to difficulties in attracting a skilled workforce, since defined benefit plans are recruitment tools that encourage qualified workers to choose lower-paid government employment. The result is higher turnover and more spending on training. And a revolving door workforce leads to lower quality public services. Reduced benefits will mean more workers retiring into poverty, harming local economies where Kentucky public pension benefits inject $3.4 billion every year.
For a variety of reasons, Kentucky faces the most challenging fiscal picture in recent memory going into the next budget session. More pain is around the corner unless we take the smart route of generating new revenue.
Another overhaul of future pension benefits is a distraction from the urgent need to deal with what’s right in front of us.
This column originally ran in the Courier-Journal on Aug. 25, 2017.
