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Defusing the Pension Bomb: How to Curb Public Retirement Costs in New York State


Defusing the Pension Bomb: How to Curb Public Retirement Costs in New York State

E. J. McMahon, Peter Ferrara November 2, 2003
Public SectorOther

Skyrocketing state and local employee pension costs have been a major factor in the fiscal crisis affecting every level of government in New York State. Taxpayer financed public pension contributions have soared by more than $2.3 billion dollars over the past two years—and are projected to rise even more in 2004. In New York City alone, the rise in pension costs will consume every dollar raised by Mayor Bloomberg’s record property tax increase.

The defined benefit (DB) pension plans used by state and local governments guarantee employees a fixed percentage of retirement income based on their peak salaries and career longevity. This requires those governments to invest money each year to cover future pension payments. But their contributions vary depending on complex actuarial assumptions and market fluctuations. As a result, the DB system is crisis prone because earnings during bull markets cover employer contributions, while losses during bear markets force governments to drastically increase contributions. Since bear markets usually coincide with recessions, DB pension plans force governments to spend more when they are least able to afford it.

This study shows how greater fairness for New York taxpayers and better retirement benefits for the majority of government employees can be achieved by switching from the current defined benefit (DB) pension plan to the defined contribution (DC) model used by the vast majority of private companies. A DC plan differs from a DB plan by requiring employers to contribute the same amount in bear and bull markets and by giving employees ownership of, and investment responsibility for, their own pension funds. A DC plan offers increased retirement equity and flexibility for the majority of public employees while providing predictable costs for taxpayers and government employers.

Under the plan proposed here, employees would be required to contribute at least 3 percent of their salaries to a retirement account. The government would match this with a minimum contribution of 5 percent, bringing the total minimum retirement savings to 8 percent of salary per year. Employers would match up to 2 percent of additional employee contributions, so that retirement savings of up to 12 percent of salary would consist of up to 7 percent from the employer and 5 percent from the employee. The recommended DC plan would effectively cap costs at 7 percent of pay, just over half the fiscal 2004-05 employer contributions for the New York State and Local Retirement System.

Taxpayers would no longer bear the risks associated with market downturns. Public pension costs for the first time would become both predictable and easily understandable, and the real costs of proposed benefit increases would be completely transparent, rather than obscured by complex actuarial calculations.