January 2012

As the strain on state and local government budgets around the country worsens, public employee unions have gone on the defensive, painting themselves as scapegoats for the financial crisis, reports The Wall Street Journal. Union leaders claim that elected officials are taking their financial troubles out on their workers. Yet if public employees are victims of anything, it is of union chiefs’ over-promising of lavish compensation well into the future.

Many on the left (including labor leaders) often call on everyone to pay their “fair share” (usually of taxes). By the logic of their own rhetoric,  public employees should do their “fair share” of cutting back during the recession. That hasn’t been the case.

Many private-company workers have seen their retirement accounts shrivel, while public-sector benefits have been relatively unscathed. Defined-contribution plans such as 401(k)s had $3.33 trillion in assets at the end of 2009, down 4% from $3.48 trillion in 2006, according to the Federal Reserve. Such accounts have lost value even though companies and workers contributed $100 billion over that period.

The rise in public-sector benefits has attracted the ire of citizens like Paul Nelson, a semi-retired investor in Upper Saddle River, N.J. Mr. Nelson, 59 years old, has a son at Northern Highlands Regional High School, where the principal says the school may have to cut teachers and increase class size. “Most public employees have retirement and health-care plans that private-sector employees can only dream of,” says Mr. Nelson.

State and local politicians bear a major share of the blame, not only by extending collective bargaining to the public sector, but also by acceding to union demands time and again. While undesirable, this is understandable. Public officials don’t face the competitive pressures to hold down costs that private businesses face. And while they do face constraints in the size of their budgets and potential negative reaction from taxpayers, those constraints only function in the present.

Thus, many public sector collective bargaining agreements back load benefits, in the form of pensions, well into the future. By the time the bill for those benefits comes due, the politicians who negotiated the union agreements will be out of office, leaving the mess for someone else to sort out. And quite a mess it is.

At the root of governments’ problems today are promises made in past decades. As a group, state and local governments have promised an estimated $3.35 trillion in pension and health-care benefits to be paid over the next three decades, but are estimated to have 70% of the money to cover those payments, according to the Pew Center on the States. Pension and health costs can consume 20% of city and state budgets.

California offers a view of the fallout. The state’s largest pension fund, the California Public Employees’ Retirement System, known as Calpers, is estimated to be only 57% to 65% funded. Having suffered investment losses in recent years, the state has had to dip deeper into its revenues to make up the funding gap. Last year, a budget impasse forced the state to issue IOUs for taxpayer refunds.

It wasn’t long ago that California was going the other way, based on a different set of assumptions. In 1999, the state’s Democratic-controlled legislature and then-governor Gray Davis passed a law expanding benefits for many state employees. A proposal prepared by Calpers—the $200 billion fund that manages money for 1.6 million of the state’s employees, retirees and their beneficiaries—forecast that the boosted benefits would be paid for entirely by investment gains.

In addition to being optimistically generous, public employee pension funds have underperformed because of politicized investment strategies that seek to advance social goals rather than focus exclusively on maximizing returns, as fiduciary duty requires. (It is worth noting that union officials sit on many state employee pension fund boards.)

While some public sector unions have agreed to concessions, it’s been when their employers — state and local governments — are facing financial disaster, as in the case of Toledo, Ohio, which as the Journal reported yesterday, “narrowly averted having the state take over its finances by filling a $48 million budget gap late Tuesday. To tackle that deficit, Mayor Michael Bell had to take on the city’s police and firefighters’ unions and propose other controversial measures.”

As other states and cities work out ways to bring their budgets under control, public employee unions may have to agree to more such concessions, due to dire state of those governments’ finances. But they never should have gotten to that point in the first place.

Worse, many union bosses may decide to wait for a taxpayer bailout rather than make concessions. As columnist Mark Hemingway explains in today’s Washington Examiner, pension underfunding is also a major problem among private sector unions, where a bailout effort is already under way. As he notes, “Rep. Earl Pomeroy, D-N.D., has introduced legislation to explicitly put taxpayers on the hook for failing union plans.”

(Subscription needed for Wall Street Journal links.)

For more on public sector unions, see here and here.

For more on pensions, see here, here, here and here.