This can't be the only backup plan as pensions struggle.

Photographer: Jeff Haynes/AFP/Getty Images

Save the Pensions: No Sudden Moves, Please

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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What do states owe workers?

That's a question we're going to be asking a lot as states wrestle with growing pension obligations that weren't properly funded. Illinois courts have just ruled that the state's attempt to curtail its pension benefits cannot go forward. The Chicago Tribune boils it down: "In its ruling, the court restated that state worker retirement benefits that are promised on the first day of work cannot be later reduced during their term of employment, only increased."

That probably sounds reasonable to a lot of readers; after all, employers shouldn't be allowed to renege on pay promises (except in bankruptcy). But Jane the Actuary, a frequent commenter here, argues that what should actually be at stake is not benefits that have already been accrued for past work, but those that will be earned in exchange for future work. Private employers are not allowed to take back benefits you already earned, and governments shouldn't do this either. But private employers can tell you that the pension fund is closed and you won't accrue any further benefits, or that benefits accrued in the future will be smaller. Should governments be able to do this too?

There are a few issues that we need to unpack here. The first is what, exactly, we owe to workers who have been at it a long time. Pensions are another form of compensation, like health care benefits or wages. But they're a strange form of compensation, because they're so heavily back-loaded. That can have benefits for both employer and employee (for example, in reducing turnover). But it also has very high costs. They reduce the mobility of workers, and can make a mid-career job loss catastrophic. Meanwhile, they create enormous difficulties for any employer who sees a shortfall in the pension just when the employer itself has fallen on hard times -- as is apt to happen during a bad recession. The problems are even worse for states and local governments than for businesses. Many of the public pensions used lax accounting standards to hand out generous benefits far in excess of what their accrued investments will support.

It's fair enough to say that workers aren't entitled to a certain benefit when they haven't done the work yet. But many of those workers took those jobs decades ago in the expectation that they would accrue those benefits in the future. This is especially true for state and local workers, who frequently seek the job expressly for the purpose of obtaining that lifetime security. Once they have essentially invested their work lives for the payoff of future benefits, it does seem unfair to go to them at age 48, when they can't realistically get a whole new career, and say "Guess what?"

On the other hand, one could point out that this sort of unfairness is not exactly unknown in the world of work. People that age lose businesses that go south because the economy changed, or they get downsized by a company that's hit a rocky patch, or see their future benefits cut when the company replaces the pension plan with a 401(k). Why are government workers special? And why should new workers have to bear all the burden of pension cuts, as frequently happens when benefits are kept for older workers? Or taxpayers have to give up on needed services now because politicians 30 years ago were grossly irresponsible?

This is an especially pressing question as we see more big governments, like Detroit, simply unable to pay their pension bills. Taxpayers cannot be treated as an infinite resource; if you try to raise too much money off of them to make good on decades-old promises, then taxpayers will flee, making the problem even worse. You are already starting to see some version of this in upstate New York, as the taxes needed to pay old-age benefits chase workers and firms to regions that are less, er, taxing. If governments cannot adjust their benefits in a more gradual manner, we are going to end up with more catastrophic defaults on pension obligations. And that doesn't seem fair to anyone.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor on this story:
Philip Gray at philipgray@bloomberg.net