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Crony Capitalism vs. Public Pensions

Saturday, February 1, 2014

A new union-sponsored study lowballs today’s pension costs by around two-thirds and overstates the net costs of corporate welfare.

The Washington Post’s Lydia DePillis recently reported on a new union-sponsored study from Good Jobs First that claims that corporate welfare payments from state governments dwarf the costs of public employee pensions.

To begin, we shouldn’t take this corporate welfare/public pensions link all that seriously. There’s no actual, causal relationship between them. If public sector pensions are excessively generous, they ought to be curbed, regardless of cost pressures. And, in my opinion, we should cut corporate welfare too — crony capitalism is no better than sweetheart deals for public employee unions.

But the Good Jobs First report is also wrong in how it compare costs. The report comes to its startling conclusion by a) understating the costs of public employee pensions; and b) overstating the net costs of corporate welfare.

If public sector pensions are excessively generous, they ought to be curbed, regardless of cost pressures.

Let’s start with pension costs. A government’s Actuarially Required Contribution (ARC) has two parts: first, the “normal cost,” which is the contribution the government makes to cover pension benefits accruing to employees in that year; and second, “amortization costs” to pay off unfunded liabilities accruing in prior years.

Both the normal cost and amortization costs are part and parcel of the pension’s costs. When a government promises employees a benefit, it is not just making a contribution today. It is taking on the contingent liability to increase contributions in the future if the plan’s investment returns come up short. But the Good Jobs First study counts only the normal cost of pensions. Amortization costs are excluded. (This wasn’t accidental; you have to know what you’re doing to pull these numbers out of pension reports.)

Let’s illustrate with Arizona, just to pick the first state in the report. In Arizona’s main state employee plan, the ARC including amortization costs is 1.6 times larger than the normal cost alone. So this is a pretty large misstatement.

The reason that states offer such subsidies is that their benefits outweigh the costs, say, by attracting businesses and jobs to the state.

The natural response from Good Jobs First would be that amortization costs aren’t a part of today’s pension costs, but just reflect unfunded liabilities from the past. Fine. But then in calculating today’s normal cost, you need to account for the risk that the plan’s investments won’t produce their assumed return (8 percent in Arizona’s case) and the state will need to pony up additional funds in the future.

Economists do this by recalculating the normal cost using a lower interest rate to reflect this guarantee made to pension participants. For example, if you assume a 4 percent yield for long-term U.S. treasury bonds, the normal cost of a pension would roughly triple versus using an 8 percent return assumption. That tripling reflects the full cost of the liability the state is taking on and the full value of the benefits promised to employees. This approach is used by the federal Bureau of Economic Analysis in analyzing state/local pension liabilities, and has been effectively endorsed by the Congressional Budget Office, the Federal Reserve, and the vast majority of professional economists. So roughly speaking, Good Jobs First is low-balling today’s pension costs by around two-thirds.

But Good Jobs First also exaggerates the costs of corporate subsidies. The reason that states offer such subsidies is because their benefits outweigh the costs, say, by attracting businesses and jobs to the state. Now, I’m very willing to accept that this isn’t the case, which is why I think we should eliminate most corporate welfare. But the Good Jobs First study assumes that the benefits of these corporate subsidies are zero, which almost certainly isn’t the case. Some jobs and businesses are created by corporate subsidies, even if the benefits aren’t worth the costs.

So yes, if you understate pension costs and overstate corporate subsidies, then pensions cost a lot less than corporate subsidies. I bow to no one in disliking corporate welfare, but the fact that the union-sponsored Good Jobs First had to go to such lengths shows exactly how expensive public employee pension plans have become.

Andrew G. Biggs is a resident scholar at the American Enterprise Institute.

FURTHER READING: Biggs also writes “Why Expanding Social Security Is a Bad Idea,”“Teachers and the License Raj,” and “Public-Sector Pensions: The Transition Costs Myth.” Caleb Brown reveals “The Real Reasons We Have a Public Pension Crisis.” Arnold Kling devises “The Recipe for Good Government.”

Image by Dianna Ingram / Bergman Group

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