There is a financial time bomb that is set to explode on our towns, cities, counties, states, and Federal government. It’s like a terrorist attack without the violence, but it will have the same or even more destructive effect on our society. The “bomb” is public pensions and medical benefits. This is a zero sum game, where either our tax rates will have to double or even triple, or public sector employees will have to accept that their retirement and medical benefits will become aligned with those of the taxpayers who fund them. There is a solution, and it will be gut wrenching but it is necessary, and an example is outlined it below.
Before I describe the solution, let me just make sure I illustrate the size of the problem. The National Bureau of Economic Research estimates the unfunded public sector pension liability at $3.23 trillion. This means that at current tax rates (indexed for inflation), and current committed retirement expenses, we need to raise $3.23 trillion ADDITIONAL tax dollars to fund these pensions. This is $10,000 for every man, woman, and child in America. As these pensions hit the books of our governments at all levels we will see annual tax increases not of 1, 2, or 3%, but more like 15, 18, or 20%. If not fixed, we will surely see an uprising equal to or greater than what we have seen in Europe in the last few months, and financial disaster will hit our country.
And one more precursor to the solution. Public sector pensions are, almost in their entirety, wildly out of line with that of the private sector. They are so generous that, for instance, your average private sector worker would have to put $2 million into their 401k account in order to generate the same retirement payment as a local police officer, fireman, or non-management bureaucrat. If you were a teacher in New Jersey or New York and retired, your retirement payment is approximately equivalent to what a private sector citizen would generate from a $3 million 401k. Think about this. A New Jersey teacher contributes nothing to retirement, while a first line manager has to put in $3 million.
Now on to the solution, which is based on principles that have been used and implemented across the private sector beginning about 15 years ago. Public sector employees may see this and scream, but if so they should keep in mind that this is what the vast majority of taxpayers (who fund public sector pensions!) went through and it’s way overdue for them, and it is a fiscal necessity.
1. Employees within 7 years of retirement: No changes to their retirement age. However, these employees should contribute 5% of the cost of their medical insurance for the remainder of their active careers and in retirement.
2. Employees 8-12 years from retirement: Increase retirement age to 60, or 25 years of service (this will be particularly challenging for many police officers who, believe it or not, are eligible for retirement after just 20 years of service). These employees should contribute 5% of the cost of their medical insurance from now until death. Each year employers contribute 2% of an employee’s annual salary to their 401k plan (this is on top of, not extracted from, their salary), the employee funds the rest.
3. Employees 12 years or more from retirement age: Increase retirement age to 65, or 30 years of service. They should contribute 5% of their medical insurance costs as active employees and in retirement. Employers contribute 2% of salary to their 401k plan (as described above) and the employee funds the rest.
If we do not take actions similar to these we will see a crisis, and the longer we take to act, the more likely a crisis is to occur. This is because each day that goes by that we don’t change the liability, more and more employees will be retiring and burdening the system.
We have seen some communities claim that they are attacking this problem because new employees are hired with less generous benefits. But this is not enough. New employee retirement benefits won’t kick in for 20-25 years. By then the bombs will have exploded, this needs to be applied to active employees.
And when public sector employees scream, and they most surely will (as we in the private sector did), just pull out the details of your retirement plan and show it to them, and ask them to explain why it is that you are paying for their salary and benefits, and your benefit plans are equal to or worse than what is proposed above.