Last week, the Obama administration’s Department of Labor released new rules allowing states to sponsor pension systems for private-sector workers whose employers don’t offer retirement plans. The decision could ultimately drive trillions of dollars of employee money into the hands of the same state officials who have mismanaged public pensions for years. What could possibly go wrong?
In recent years, politicians in state capitals have called for the government to provide retirement security to workers who lack employer-provided pensions, even though those workers are already eligible to start their own IRAs under federal rules. Officials in about two dozen states—including California, Illinois, and Connecticut—proposed state-run private pensions. Workers would be automatically enrolled and, unless they opted out, would see regular deductions made from their paychecks. But states were waiting for the Obama administration to create a “safe harbor” rule allowing them to operate these new plans according to their own laws, not the federal Employee Retirement Income Security Act (ERISA). Last week, the administration complied.
Taxpayers should be worried. State and local pension plans for public sector workers are already exempt from ERISA. Much of the debt they have accumulated is due to the weaker standards under which they operate. Indeed, the states that have gone furthest in studying private pension plans are among those with the most-indebted public-sector pension systems.
California’s proposed new law aims to deduct 3 percent from the paychecks of workers who aren’t covered by another pension system. The money would then be invested in highly rated U.S. government securities. An early version of the law also guaranteed workers a modest rate of return over time, but legislators dropped that stipulation because of criticism that the plan could produce the kind of burden on taxpayers that California’s retirement systems for public workers has accumulated—at least $170 billion by the state’s own accounting, and potentially much more using more conservative market assumptions.
Still, there are dangers for taxpayers. Most government-worker pension plans started out with similar modest assumptions meant to protect taxpayers from getting stuck with big bills. Over time, political pressure eroded these safeguards. Indeed, the original 1929 design for the California state-worker retirement system limited its investments to riskless government securities. “An unsound system is worse than none,” warned its designers. Yet, successive legislatures increased benefits and lifted investing restrictions, allowing the retirement system to pour money into risky stocks. California wound up with exactly the kind of system that it once sought to avoid. One can easily imagine a similar scenario where the pension savings from a state-run plan for private workers are suddenly deemed inadequate and elected officials rush to increase payouts at the expense of the long-term stability of the plan.
There are many unanswered questions about how the new retirement plans will work, including who will be responsible for investing the money and what kinds of investment choices workers will receive. For taxpayers, the biggest long-term risk may lie in the ERISA exemption. Lawsuits filed by workers over these retirement accounts could end up in state courts, which have a tradition of going to extremes to protect workers’ retirement plans. California state courts, for instance, have ruled that the government can never change the terms of state-worker pension contracts—even for work that workers have yet to do. This makes it virtually impossible to save money immediately once the system gets into trouble. Illinois’s supreme court has bluntly told legislators it should raise taxes to pay off its pension debt. Federal courts, by contrast, have interpreted ERISA to allow companies that sponsor pension plans to change the terms of the pension contract for future work by current workers—allowing immediate savings.
The new rules suggest that the Obama administration is shepherding a government takeover of the private retirement market. Earlier this year, the administration debuted tough new standards for investment advisers who provide guidance for private sector retirement plans. The new standards, argues the Financial Services Institute, will drive up the price of operating a private retirement plan, and may eventually prompt companies to avoid starting such plans. State governments could then push those pensionless workers into their own systems, which operate under looser standards.
There are alternatives. The federal government could induce workers to save more for retirement by reducing regulations on already-existing private plans. One change, for instance, would allow businesses with fewer than 100 workers to offer an existing product, the Simple IRA, without requiring firms to make minimum contributions. Currently, businesses that enroll workers must match employee contributions up to 3 percent of salary.
States don’t need to run their own private-worker pension plans. Washington State is establishing a small-business retirement marketplace that matches employers with financial firms offering retirement plans. New Jersey has followed Washington’s lead.
Voters, for the most part, have stood by and watched the creation of these new plans. After all, a government program to help you save for retirement sounds like a good thing. But these same voters are currently being asked to pay more in taxes to support government pensions for public-sector workers that they were once assured were safe. Where’s the outrage? It’s not there, in part, because it takes years for the obligations of plans like these to materialize. The real burden of anything that goes wrong will fall on the next generation. Given the rate at which the public-pension crisis is metastasizing, that could leave tomorrow’s taxpayers with double pension trouble.
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