Why are pensions a problem?

For decades, local and state governments have guaranteed employees that they can retire on comfortable—and in some cases, lavish—pensions. Officials assumed that taxes, investments, and other revenues would rise over time, covering the cost. That assumption has turned out to be wrong. Taxpayers are now on the hook to provide pensions to 80 percent of the nation’s 27 million state and local government workers and retirees. The combined shortfall in funding those pensions could be as much as $3.4 trillion—more than double this year’s federal deficit. Even using a rosy projection that pension-investment portfolios will return 8 percent annually, seven states, including Illinois, Connecticut, and Louisiana, are on track to exhaust their pension funds within a decade. More than half of state pension funds will run dry by 2027. “This charade can’t last,” wrote former Los Angeles Mayor Richard Riordan and investment advisor Alexander Rubalcava in The New York Times. “In many cities, pension obligations will soon consume a quarter or more of the annual budget—money that will be unavailable for parks, libraries, street maintenance, and public safety.”

How did governments miscalculate so badly?

Pension funds subsist on three revenue streams: employee contributions, employer contributions, and investment earnings. During the 1990s, soaring stock prices swelled the value of pension funds, enabling states and municipalities to reduce their own contributions and those from employees. They also acceded to public union demands to increase benefits. “Everybody was raising benefits without thinking of the long term,” said Kil Huh, director of research for the Pew Center on the States. Governments began assuming they could count on rising markets and high investment returns indefinitely. But in the wake of the 2008 financial crisis, stock prices plummeted, eventually declining 56 percent from their 2007 peak; pension portfolios were devastated. The loss in equity was exacerbated by the plunge in tax revenues that also accompanied the Great Recession.

How generous are benefits?

They vary dramatically. The average annual benefit in 2008 was $22,780, according to the Center for Retirement Research at Boston College, a figure that includes part-time workers. But some public employees receive benefits far beyond average. More than 9,000 beneficiaries of CalPERS, California’s state retirement plan, which is the nation’s largest, receive six-figure annual pensions. In Yonkers, N.Y., taxpayers were outraged to learn that some police officers who had retired in their 40s were collecting six-figure pensions for life; former cop Hugo Tassone, for example, retired at 44 with a $101,333 pension. Edward A. Stolzenberg, a former public hospital administrator in New York’s Westchester County, receives $222,143 annually. “It may not be viable,” Stolzenberg acknowledged. “But that’s the way the state structured it.”

What about the cost of current workers?

It’s also part of the problem. While median family income actually declined over the past decade, salaries for public workers continued to rise. Blue-collar public workers with a high school education now earn, on average, more than their private-sector counterparts—$53,880 annually compared with $50,596. White-collar public-sector employees, however, fare less well. Those with professional degrees earn an average of $121,192 in the public sector, compared with $192,977 in the private sector. But with state budgets under duress and unemployment stuck at around 9.6 percent, public workers’ salaries and benefits are now coming under increased scrutiny. Taxpayer groups in California, which has a projected $19 billion budget deficit, want to cut salaries and take an ax to the most generous public pensions. But most state constitutions explicitly guarantee benefits that have accrued from work already completed. Even when municipalities have declared bankruptcy, their employee pension benefits have been paid.

Can benefits be scaled back?

Only for future employees. New Jersey Gov. Chris Christie recently signed legislation reducing pension benefits for new state employees. In California this month, voters in nine municipalities approved ballot measures to limit benefits for future public employees. And governments are starting to take a harder line in collective bargaining with public unions. “I’ve seen a sea change in the local collective bargaining process,” said Dwight Stenbakken, deputy executive director of the League of California Cities. Some analysts recommend following the lead of Georgia, which requires that prior to being enacted, any changes to retiree benefits be studied for long-term impacts. According to the Pew Center on the States, the policy has helped Georgia avoid “costly and irreversible” mistakes.

What if reform efforts fail?

Look out. If states run out of pension reserves, they’ll be forced to dip into operating budgets to pay benefits—siphoning money from schools, health care, and other vital services. Because most states are required to balance their budgets, tax increases or cuts to government services are the only options. In every region of the country, the high-rolling days are gone and the public-pension bill is coming due. “This is not a conservative-versus-liberal issue,” said Dan Liljenquist, a Utah state senator and pension-reform advocate, “this is a reality issue.”

Pay to play

With vast sums dedicated to public pensions, the potential for corruption is ever-present. In New York last week, prosecutors said they were on the verge of obtaining another guilty plea in the state’s “pay to play” scandal, just four weeks after former state Comptroller Alan Hevesi pleaded guilty to corruption. According to court documents, Hank Morris, Hevesi’s longtime political consultant, and other Hevesi aides steered billions in public-pension funds to investment firms that paid Morris for serving as the intermediary. Morris received some $15 million in fees. Investment firms that declined to pay were restricted from the “play”—the collection of fees for managing the pension fund’s investments. Because Hevesi was the sole trustee of the state’s $125 billion public-pension system, it was particularly ripe for abuse. The scandal, said New York Attorney General Andrew Cuomo, represented “the worst of the private-sector financial community meeting the worst of the state government.”