What happens when the claim to some financial right from the government creates some financial “wrong” somewhere else?
That is, when the government’s balance sheets don’t balance, and there aren’t enough assets to pay for claims on them, someone must get short-changed. If that “someone” must accept unequal treatment under the law, has the right been matched by a “wrong?” These issues have now arisen for underfunded state pension plans, but they continue to apply in other arenas, such as the unequal assessment of property taxes in states like California. In these and other cases, the young often end up paying the piper.
Protecting rights has long been crucial to maintaining a democratic order. The United States has a long history of protecting citizens’ rights, embedded from the beginning of the nation in the Bill of Rights and, since then, in many legal and constitutional clauses. These aim largely to establish liberty and require equal treatment under the law. When it comes more narrowly to most disputes over private property and assets, there are no “unfunded” government promises; contestants simply dispute over who gets the private funds. The court effectively fills out the balance sheet when it resolves those private disputes. A higher inheritance to one party out of a known amount of estate assets, for example, means a lower amount for another. There’s no third party or unidentified taxpayer who must to contribute or add to the estate so all potential inheritors can walk away happy.
When it comes to financial “rights” established by law, the issue becomes more complicated. The latest cases getting much attention revolve around the rights of state and local public employees to the benefits promised by their pension plans, even when those plans do not have the assets to cover the claims. Some courts have determined that the promised benefits are inviolable under state constitutions, regardless of available assets; other courts have recently interpreted state laws differently, led by the bankruptcy and financial distress of state pension plans.
As another example, some states give longer-term homeowners rights to lower taxation rates than newer homeowners. Proposition 13 of the California Constitution requires that property taxes cannot be increased by more than a certain rate, effectively granting existing homeowners lower tax rates than new homeowners receiving the same services for their tax dollars.
So where does the money come from? Saying that it can be the future taxpayer still dodges the issue of whether the allocation of benefits and costs meets a standard of equal justice.
Thus, when people lay claim to nonexistent government assets, “rights” can’t be totally separated from the “accounting” system under which they are assessed. I’m not a lawyer, but I believe courts and legislators do not do their job completely if they don’t admit to and address the following questions in any disputes on such matters:
- How can we judge anyone’s right to some financial compensation, pension benefit, or lower tax rate without at least knowing where and how the balance sheet is or might be filled out?
- How does the claim to a right by one set of citizens affect the rights of other citizens?
Even when courts determine that any resulting injustice is constitutional or the prerogative of the legislature, they still should do their balance-sheet homework.
In some arenas, the courts have made clear that the lack of underlying funds limits the rights of people to some promised benefit. The United States Supreme Court has stated, for instance, that Social Security benefits can be changed regardless of past legislative promises. This system is largely pay-as-you-go: benefits for the elderly come almost entirely from the taxes of the nonelderly. Because promised cash benefits now increasingly exceed taxes scheduled to be collected, even the pay-as-you-go balance sheet has not been filled out: some past Congress promised that benefits would grow over time without figuring out who would pay for that growth. Legislators can rebalance those sheets constitutionally without violating the rights of a current or future beneficiary. Whether they do so fairly is another matter.
When the courts have leaned toward treating as unalterable the rights of some citizens to unfunded promises made in the past, however, they have directly or indirectly required some unequal treatment under the law, with the young often paying the piper.
Our Urban Institute study of pension reforms in many states reveals that efforts to protect existing but not new state pensions almost always requires the young to receive significantly lower rates of total compensation than older workers doing the same work. Worse yet, we have determined that to cover unfunded liabilities from the past, some states are adopting pension plans that grant NEGATIVE employer pension or retirement plan benefits to new workers, essentially by requiring them to contribute more to the plan than most can expect to get back in future benefits.
In the case of California’s limited property tax increases, new, younger homeowners are required to pay much higher taxes than wealthier, older, and longer-term homeowners.
In these cases, it seems fairly clear that the “rights” of existing state workers or homeowners leads to an assessment of “wrongs”—unequal taxation of unequal pay for equal work—on others, mainly the young, to fill out the balance sheets.
As I say, I’m not a lawyer, but I do know that 2 + 2 does not equal 3. When the courts say that you are entitled to $2 and I’m entitled to $2, they can eventually defy the laws of mathematics if only $3 is available. It’s not that the declining availability of pension benefits to many workers and rapidly rising taxes are problems to be ignored. It’s just that assessing wrongs or liabilities on unrelated parties to a dispute is unlikely to represent equal justice under the law or an efficient way to resolve public finance issues.
Recent stories about Chicago’s pension crisis represent only the latest in a long series of announcements about poorly funded state and local pension plans. Detroit’s declaration of bankruptcy shows one possible consequence of such neglect, with many of the city’s retirees fearing drastically reduced pension payments. This isn’t the first time that retirees and workers have found their financial stability threatened, either: many private pension plans have failed in such industries as steel production and airlines.
While there’s often no easy or right answer for who should pay for these uncovered burdens, as a society we’ve pretty much decided that in this arena, as in so many others, the young should get the shaft.
Often poorly funded or badly designed to deal with risk, many pension plans need only some catalytic economic change, whether from greater competition or an economic downturn, to start sinking rapidly. A promise for the future, underfunded from the past, shifts liabilities forward in time, where they get passed around like a hot potato. No one—employer, worker, or taxpayer—wants to get burned with the cost of past mistakes, or even part of it. But the money that should have been set aside has long been spent, so someone at some time must cover the shortfall.
Consider why government or private employers underfund a plan in the first place. In a private plan, underfunding allows higher wages to current workers, bonuses to top managers, and cash withdrawals to partners and dividend recipients. In a public plan, elected officials can give higher current compensation to workers or more services to the population while letting taxpayers off the hook–temporarily, of course.
When people see this inadequately supported edifice begin to crumble, they make a run on the bank. Given the increased threats to future wages, job security, and dividend payments, everyone has an incentive to get what they can while the getting is good. Keep wages up as long as possible, even if that means further weakening pension plans. Increase those bonuses to top managers, who suggest their skills are needed now more than ever to dampen the firm’s or agency’s fall. Lobby Congress and state legislators to allow employers to defer better funding of their pension plans so these other cash outflows can continue. And maintain pension payments for current and near-retirees regardless of the hit on those not yet retired.
Traditional actuarial calculations—the formulas by which actuaries determine whether employers adequately fund their plans—make matters worse. These formulas often allow employers to play Wall Street with their pensions. A firm or government borrows at low interest rates on one side of the ledger, then invests in riskier assets with higher expected returns on the other side. Even dodging the question of when such practices generally make sense, employers often push their actuaries to use outrageous assumptions about rates of return on those risky assets.
For instance, many state and local governments today assume a return of around 8 percent on a mixed portfolio of bonds and stocks in a world where interest-bearing bonds often yield only 3 or 4 percent at best and the earnings-to-price ratio (the effective rate of return earned by corporations relative to the price of their stock) is about 6 percent in real terms. If these employers want to play the markets with their pension plans, then the plans should be overfunded enough to handle the risk. Alternatively, governments and firms should make their projections assuming a less risky but lower rate of return. If the risk-taking strategy works, then future (not current) funding payments can be lowered.
When the firm or government declares bankruptcy, many bondholders, pensioners, and remaining workers deserve sympathy. Certainly the retiree who might have to rely on less than expected, the bondholder who accepted a lower rate of return in exchange for what she thought was a less risky investment, and the taxpayer who often gets caught covering everyone else’s problems. Sometimes these are the same people who benefited from the excessive payments (made possible, first, when inadequate funds were put into the pension plan, and then, during the delay between recognizing the problem and taking some later action such as bankruptcy). But often they are not.
While these claimants may battle each other, they almost always collude against the young. The use of unreasonable actuarial assumptions establishes this pattern by forcing future workers and taxpayers to cover shortfalls. In addition to covering some of those losses, new workers for the state or the firm, if it survives, will be granted far fewer pension or retirement plan benefits than even current workers, not merely those already retired.
Unequal pay for equal work becomes the new standard. Age discrimination against the old is illegal, but not the young. State pension plans now typically provide tiered benefits, with successively lower benefits for newer workers. In fact, states are now starting to provide negative employer benefits to the young by giving them back less in benefits than their contributions plus some modest rate of return.
The same holds in different ways in private industry. We are all familiar with the higher cash and pension benefits being paid to older airline pilots and automobile workers, among others. Almost no one addresses the consequences for wealth-building, including retirement adequacy, for today’s young. That’s tomorrow’s problem.
Or is it? Seems like we’ve heard that claim before.