Short-term legislative fixes have reduced Louisiana’s budget shortfall to $600 million. However, structural budget problems largely have been ignored, like Louisiana’s unfunded pension liabilities that cost the state about $1.5 billion in interest last year.
With only 60 cents for every dollar that it owes, Louisiana has some of the nation’s most poorly funded pension systems. This amounts to over $19 billion in unfunded pension liabilities, or over $4,000 per person, and these projections likely are too rosy. Some estimates put Louisiana’s unfunded pension liabilities in excess of $70 billion, or $16,000 per person.
Louisiana and most other states use defined benefit pension plans. Defined benefit plans provide public employee retirees with guaranteed payments for life based on a formula that considers years of service and average compensation. The average compensation formula only takes into account the highest three to five years of compensation. Public pensions are funded in part through contributions based upon a percentage of the employee’s actual compensation. This, in addition to poor investment performance and the Legislature’s fiscal irresponsibility, creates unfunded liabilities.
If the public employee pension fund runs out of money, the state — more specifically, the taxpayer — is on the hook for the debt. Public employee pensions are protected by the Louisiana Constitution, and the state cannot declare bankruptcy.
Since the debt must be paid, taxes have to be increased or services reduced. Tax hikes are seldom popular, especially when the tax is not covering a service. Likewise, reducing public education and safety spending in order to fund pensions is an unappealing proposition. New Orleans already is experiencing this as it spends more on firefighter pensions than it does on Fire Department operations.
Although public employee defined benefit plans are wreaking havoc with government budgets across the country, politicians usually like them. Increasing public pension benefits is a surefire way to score immediate political points with influential public sector unions, and the increased pension benefits won’t have to be paid until 20-plus years down the road. Consequently, politicians have no incentive to be responsible because they will be out of office when the bill comes due. Thus, defined benefit plans allow politicians to have their cake and eat it too, then pass the check to the next guy.
The private sector transitioned away from defined benefit plans decades ago, and so should Louisiana. Private pension plans are usually 401(k)-style savings accounts, so a person’s retirement benefit equals his account balance, a combination of employee and employer contributions, as well as investment returns. This prevents unfunded liabilities from piling up and placing an unreasonable burden on taxpayers.
States are starting to shift away from pure defined benefit plans and embrace aspects of 401(k) plans. For example, Utah created a hybrid pension system, one with aspects of a defined benefit plan and a 401(k), in 2010. Economic simulations by Brigham Young University concluded the Utah Retirement System had a 50 percent chance of insolvency by 2028 prior to the reform. Thanks to the reform, Utah’s pension system is expected to remain solvent for the foreseeable future.
Despite claims to the contrary, public employees would benefit from hybrid-style plans. Pensions are a form of deferred compensation, so reducing pension costs enables employees to receive higher wages. Defined benefit plans also are designed for those who remain with the same employer for long periods of time. This creates an incentive for a dissatisfied employee to remain at a job she hates; however, this situation does not produce the employee’s best performance, which is what the taxpayer deserves since the taxpayer is paying the tab. Hybrid plans usually have greater portability than defined benefit plans, enabling unhappy employees to change jobs without losing their retirement benefits.
Unfortunately, the Louisiana Legislature is not ready to address the state’s pension woes. State Rep. Barry Ivey offered a bill that would have created a hybrid pension system but withdrew it due to overwhelming opposition. And in a move that will exacerbate the state’s pension debt, the Legislature unanimously agreed to increase pension benefits.
Louisiana’s pension systems are unsustainable in their current form. Eventually the Legislature will have to face this fact. The longer Louisiana waits to revamp its pension systems, the longer it will be stuck in a vicious cycle of budget shortfalls, service cuts and tax hikes.
Adam Crepelle is an adjunct scholar at the Pelican Institute for Public Policy, a New Orleans-based group that studies state issues and promotes conservative economic principles.