President Obama was much maligned for contributing an additional $8.75 trillion to the national debt, pushing it from $11 trillion to around $19 trillion before he left office. However, President Trump is contributing to the national debt at a similar pace, on track to add $4 trillion to the national debt by the end of his first term despite a robust and growing economy [1]. As the U.S. government spends far beyond its means, it struggles to cover its “mandatory spending” obligations, such as Social Security, Medicare, and Medicaid, in addition to public pensions. The public sector is one of the few entities that offers pensions or “defined benefit” plans. With these plans the government sets aside a portion of the employee’s paycheck to invest in a fund that grows and is then given to the employee upon retirement. In 2018, Moody’s Investor Service, a ratings agency, estimated that public pensions are underfunded by $4.4 trillion, an amount equivalent to the economy of Germany [2]. With spending deficits ballooning and pension plans disappearing in the private sector due to economic infeasibility, it is wrong for the government to continue funding public pensions.
The emergence of the 401(k) plan in the Revenue Act of 1978 helped companies move away from burdensome pension plans, allowing them to reduce costs and transfer investment risk to the employee [3]. 401(k) plans allow employees to choose their investment plan, with employers often matching employees’ contributions. As employees assume this responsibility they are rewarded with greater economic liberty, no longer tied to a particular employer’s pension plan. On the other hand, those in the public sector often take lower salaries than those in the private sector because of the guarantee of a pension waiting for them upon retirement.
However, the government has hurt public employees and taxpayers alike by allowing $4 trillion in unfunded pension liabilities to accumulate. This funding gap has stockpiled due to faulty economic forecasts along with misaligned funding priorities. Government economists claim that pension funds experience a solid rate of growth, usually around seven to eight percent. Even if that rate drops, they say that the rate will average out over time due to the government being a long term entity; i.e. the government will never go out of business like companies in the private sector. This reasoning is flawed, as pension funds have been shown to consistently miss their projected growth rates as finance economists use a risk-adjusted rate of return which tends to be several points lower than projected. Compounding this low growth rate is even lower government funding for pensions. While the government is forced to pay pensions by law, it is not legally required to fund them. Indeed, pension funding is one of the first cuts made during hard times [4].
As this funding gap widens, the government is forced to increase spending on “amortization” payments, those that work to cover the unfunded amount, further decreasing the available spending for scheduled pension contributions. A recent government report claimed that pensions are 72% funded, with the remaining 28% going to amortization payments. Economists have projected the real rate of funding is closer to 45%, with 55% of pension spending focused on closing the gap of unfunded liabilities [5].
Here is where an unstoppable force meets an immovable object, the former being the rising cost of pensions, the latter being the legal requirement to pay out pensions. With pension costs rising due to the longevity of workers and underfunding, some state governments have become so entangled that the only way out is through a “grand bargain” with the state’s workers [6]. Unfortunately for those in the private sector, the law does not mandate that workers receive their FICA benefits such as Medicare and Social Security (Nestor v. Flemming) even though they are legally required to pay FICA taxes [7]. The funding gap is swept under the rug because government officials fear the potential blowback. They fear that exposure of the underfunding will cause the private sector to call for cuts to public pensions, as they have become the primary sources for said pensions. Then, those in legislative positions fear that they will have to resort to higher taxes to salvage their pensions, an injustice that would have to be imposed on their constituents.
Moving forward there are two real solutions. The first option is to cut payments to those who have already retired. While saving money in the short-term, it hurts those relying on public pensions for income and ultimately fails to solve the issue of underfunding. The second option is to switch all current government workers to 401(k)s, like those in the private sector, which would set the government on a course to slowly eliminate the $4 trillion in unfunded liabilities [8]. This could be done by collecting the benefits public employees have already accrued and investing them into a 401(k). The government should follow in the steps of the private sector of the late seventies and eighties: shifting the responsibility of investment to the employee. Doing so would allow the government to slash pension funding and resort to the sensible act of matching 401(k) contributions. It is unethical to ask taxpayers to finance the mess left by various public officials, especially when the private sector has had to dump pensions due to economic infeasibility. Regardless, with national debt skyrocketing, the government must take action to eliminate the $4 trillion gap that currently exists with public pensions.
[1] https://nationalpost.com/news/the-utterly-unbelievable-scale-of-u-s-debt-right-now
[2] http://knowledge.wharton.upenn.edu/article/the-time-bomb-inside-public-pension-plans/
[3] https://www.forbes.com/sites/impactpartners/2018/02/09/where-did-all-the-pensions-go/#3826e7033aab
[4] https://www.heritage.org/social-security/report/nine-fallacies-used-defend-public-sector-pensions
[5] https://www.marketwatch.com/story/dont-confuse-public-pension-cost-with-generosity-2018-08-14
[6]http://knowledge.wharton.upenn.edu/article/the-time-bomb-inside-public-pension-plans/