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Public Workers: Overpaid? Underfunded?

I make it a practice not to disagree with Jonathan, especially in his own house. And I don't really disagree with his recent piece on public retirement benefits. I will simply register a slightly discordant, but friendly amendment to his remarks.

Jonathan is right in almost everything he wrote. He was right to slam Republican efforts to blame public workers or unfunded pension liabilities for states' budget woes. Economic crisis has caused state tax revenues to plummet at precisely the moment that rising numbers of people require costly state-funded services. It's as simple as that.

He was also right to note that voter frustration about generous public pensions largely reflects the erosion of private retirement benefits rather than the alleged excessive benefits provided to government workers. When one considers total compensation—including such details as the fact that many public employees don't receive Social Security—it's not at all clear that public workers are overpaid.

It is clear that teachers, firefighters, social workers, nurses, and, yes, those maligned bureaucrats, do hard and important work that deserves recognition. I often hear private-sector professionals complain about public-sector workers. Many of the complainers would crash and burn if they were made vice-principal of a local school or put in charge of a police sub-station. Many of these workers have accepted lower wages or more challenging work conditions in exchange for generous retirement benefits. To renege on these promises would be legally and morally dubious, to say the least.

One must also distinguish the different issues in play. Public employee unions stand accused of maximizing their members' compensation and broader well-being. Well yes. What else were they supposed to do? Public workers might or might not be overpaid. (I think not.) Whatever the answer to these questions, states and localities should properly finance their retirement benefits. Unions did not operate state comptroller's offices. Nor were unions the ones who decided to invest already-underfunded pension funds in mortgage-backed securities and other risky investments.

These arguments duly noted, I would note several things that Jonathan did not say which complicate the case. Unfunded retirement obligations are a greater problem than he fully considers, one for which public employee unions indeed bear some responsibility. Unfunded liabilities are an outgrowth of the public's unwillingness to properly finance state and local government, and of our collective failure to build responsible and transparent systems of public management. Progressives should acknowledge a few realities that should be addressed.

We should first note the pathological political economy that shapes many state and local budgets. Several inter-connected challenges hinder sound budgeting. In many states, voters are extremely reluctant to paying a true living wage or an outright competitive salary for many public jobs. Voters are reluctant to pay the required taxes; they are also not happy to pay what you need to pay to attract good lawyers, accountants, computer programmers, and math teachers for key jobs. States have balanced budget requirements on current spending, which reinforce these tendencies.

In an unfortunate combination, many states and localities have poor monitoring and financial control mechanisms to regulate the fine print in labor contracts. Voters are relatively clueless and innumerate. The news media generally does a poor job of scrutinizing or explaining these issues, too. In principle, governors and legislators have the information and skills to take a longer view. In practice, many are motivated by short-term political considerations. The professionalism and quality of state and local governance in these matters often leaves much to be desired. Many states lack credible counterparts to the Office of Management and Budget or the Congressional Budget Office. These are sorely needed.

Add one more uncomfortable reality. Jonathan compares conservative scandal-mongering about public retirees to earlier conservative scandal-mongering about welfare queens. This is a telling comment regarding conservative rhetoric, but there is one key difference. Welfare recipients are disorganized and rather powerless. Politically, nobody really cared whether AFDC recipients supported welfare reform. The voices of low-income mothers on welfare were at-best ignored over many years in Congressional welfare policy debate. Public employees are major political players.

Union votes, organizational skills, and funds provide considerable sinew for the modern Democratic Party. Especially in low-turnout state and local elections, public-sector unions matter a lot. I'm fine with that. Public employees have earned their seat at the table. They are part of the solution, not part of the problem, in addressing serious public concerns. Yet precisely because they have won a seat at the table, they bear some responsibility for the results.

Adding all these things together, one has a recipe for serious problems. The current generation of elected officials and public employees face obvious and powerful incentives to heavily back-load employee compensation in collective bargaining agreements. On the merits, most of these agreements would be amply justified if they were properly financed, but of course they often are not. The same incentives to back-load employee compensation operate to under-fund the resulting obligations.

In the final punch, pension fund managers face increasing pressures to chase higher returns as the depth of the underfunding comes closer into view. There is always someone on Wall Street offering some exotic or risky asset to meet these needs. Sometimes, pension managers got lucky in this process. In 2007 and 2008 (say), some placed unluckier bets.

There is just too much temptation, on both sides of the bargaining table, to kick the can down the road for someone to fix in 2020 or 2030. When this happens, future taxpayers, policymakers, and ultimately future generations of public employees face the consequences of these decisions. Already in many states, 25-year-old teachers and firefighters are not getting the same deals that their 50-year-old peers have gotten. This pattern emerges at the same moment that seniority-based layoff policies place additional insecurities on the next generation of public employees. As in the private sector, such tiering is likely to get worse.

Some of these issues came to public view with the release of a recent Pew Foundation report that outlined $1 trillion in unfunded state pension obligations. As Dean Baker rightly notes, this $1 trillion figure is much less scary when it is put into proper perspective. States spend about $2 trillion every year. These unfunded liabilities will unfold over several decades. Properly amortized, on average these obligations amount to a few percent of ongoing revenues and expenditures across the fifty states.

Still, this is a real problem, especially when one considers that Pew probably understated the true unfunded liability. Pew's numbers mostly come from mid-2008 or earlier. These do not fully reflect later market setbacks. City and county pension obligations might also be included in the mix. States and localities bear significant unfunded obligations for retiree health care that make the picture look even worse. The resulting fiscal burdens might be even higher, were it not for implicit guarantees lurking in the background that lower states' and localities' borrowing costs by shifting risks to higher levels of government.

I should note that the worst budgetary pathologies occur in a relative handful of specific places. Many states have done a good job, and handle their pension and health obligations well. I myself live in a state that has done a bad job, arguably the worst job in the entire country.

Illinois has more than $100 billion in unfunded state benefit and pension liabilities. At last count, the state has funded about 38 percent of its pension obligations and about 0% of what it has promised in retiree health benefits. If one assumes borrowing costs in the neighborhood of 5 percent, unfunded state retiree benefits could easily soak up 20 percent of ongoing general revenue. (And these figures do not count some serious additional liabilities at lower levels of government. Some local pension accounts are slated to go insolvent in 2017 or 2018.)

By any measure this is a significant public management failure, abetted by both Democrats and Republicans over many years. The fact that conservative demagogue the problem should not divert us from recognizing the need to find an effective and sustainable solution to it.

This brings us to Jonathan's, and Dean Baker's most important underlying point. In absolute economic terms, unfunded public employee pensions are quite manageable, even in states such as Illinois that have badly screwed up. Our gross state product exceeds $600 billion. We also have very low income taxes. To slightly oversimplify things, we impose a 3 percent flat tax. Last April 15, I paid about $0.13 in state income taxes for every dollar I paid to the federal government.

If we modestly increase our state income tax by one or two percentage-points (with rates weighted towards the affluent), we could finance much of our unfunded retiree obligations while retaining quite reasonable state tax burdens by comparison to neighboring states. We desperately need a tax increase, not only to address our pension obligations but to address other long-term needs in Medicaid, social services, education, and more. Illinois voters support the provision of fairly generous services. We have not created a tax structure to finance these same services. This imbalance only increases the pressures for budget shenanigans that create the appearance of bridging the fiscal gap.

This is also where the intersection of bad politics and bad public management thwart our efforts. The embarrassing budget shenanigans that worsen our structural deficit also undermine the political legitimacy of the very policies we now need to fix the budget mess. Voters are in no mood to send more tax money to Springfield. Watching various governors in legal trouble, reading about scandals, most recently including an incessantly-covered University of Illinois "clout list" of politically connected applicants, I can't blame voters for being cynical.

Where does this leave us?

We should not allow people to scapegoat public workers or to exaggerate the public pension problem. We also must make clear that the lion's share of the blame for problems that do exist resides with the public officials who mismanaged budgets and pensions funds, not with the unions which struck generally quite defensible collective bargaining agreements for their members.

Yet progressives would be wise to support more professional and transparent budget processes than we currently have. In the long-run, such transparency is essential for sustainable and credible activist government. Conservatives sought to "starve the beast" in the hope of forcing unpalatable long-term budget cuts. Such brinksmanship didn't work, though it has wreaked fiscal havoc. "Feeding the beast" through back-loaded unfunded obligations could prove equally damaging to progressive efforts, and for similar reasons. Such chronic debts deprives activist government of needed revenue.

Efforts right now to place state budgets on a sound fiscal footing are essential to win public support for difficult tax measures. Smart progressives understand that, which is why some of the best budget analysis of state and local policies is done by liberal advocacy organizations.

For similar reasons, I think it's reasonable for the federal government to demand that some states implement long-term budgetary fixes and improved budget practices in return for immediate fiscal help. Pew identified eight states in which at least one-third of pension liabilities remain unfunded. I would start with them.

Harold Pollack is a professor at the University of Chicago School of Social Service Administration.