Pension Recommendations Emphasize Employee Sacrifice While Addressing Only Portion of Liability
The state’s task force on public pensions heard consultants’ recommendations this week that include several ways to raise employee costs and cut benefits, some of which may not be legal. Yet even if all of the recommendations were to become law they would only reduce a small portion of Kentucky’s unfunded pension liability.
This limited impact and emphasis on employee sacrifice are the results of an approach that includes just one revenue measure (taxing retirement benefits) rather than the kind of broad, long-term revenue plan that is needed to truly address the problem.
The recommendations, which come from the Pew and Arnold foundations, include ideas to refinance the debt, suspend cost-of-living-adjustments (COLA), increase employee contributions, and put more money into the retirement system including through applying income taxes to retirement income. The packages of options presented by the consultants would only address about one-fourth of the unfunded liability.
Public employees would face higher costs under proposals to increase employee contributions by 1 to 2 percent. Their benefits would be reduced through an indefinite suspension of COLAs, the movement of new employees into inferior cash balance or hybrid retirement plans, and the application of income taxes to retirement benefits. But a portion of these proposals could be considered part of the inviolable contract and thus legally protected, including increases in current employees’ contributions and the proposal to tax employee pensions earned before 1998.
The consultants suggest issuing a bond to address solvency in the Kentucky Employee Retirement System non-hazardous plan and potentially save costs on the difference between investment earnings and bond payments. However, the state budget office told Pew and Arnold to expect costs of 6.2 percent on a pension obligation bond—higher than the 4.5 percent cost discussed in earlier task force meetings and the 4.2 percent rate at which Fort Lauderdale, Florida recently issued a similar bond.
The consultants put forward the option of extending the timeline used to pay the existing liability from its current 25 years to 30, a proposal that would actually increase long-term costs to the state.
The other recommendations involve putting more state money into the retirement system. One proposal is to ramp up annual contributions more quickly, yet the consultants do not identify where the funds for those additional payments would come from. Another proposal is to tax retirement benefits—both from public and private retirement income—and dedicate those funds to the pension system.
As we have noted previously, additional state contributions are the only way to truly and fairly address the liability problem. Past legislatures kept state taxes artificially low while not meeting their obligation to employees’ pensions. Not making payments on time has made the debt bigger. The sooner the state identifies resources to dedicate to the system, the smaller the impact of the liability on other state services like education and health.
The proposals that ask employees to make big sacrifices don’t actually make much of a dent in the problem. The proposal for increased employee contributions would reduce the unfunded liability by only about eight percent. Suspending COLAs just keeps the liability from getting bigger. And the proposals for a cash balance or hybrid plan for new employees do not reduce the unfunded liability because their costs to the state are the same as the current defined benefit plan for new employees (but with lower benefits and greater risk for workers).
Employees who haven’t gotten raises for years, made their contributions to the pension system while the state did not, and are undercompensated compared to their private sector counterparts are being asked to give up more in these recommendations. Yet the bulk of the problem is not being addressed in the plan because of its limited new revenue. The longer the legislature waits to address this and other serious resource challenges, the more harmful the impact on the state’s future.