What are states doing on retirement benefits?

Only halfway through 2011, a number of states have reformed their laws governing public sector workers' benefits, a few of them in dramatic fashion. The need to close the yawning gap between promises made to workers and the dollars saved for them on states' balances sheets is evident. According to a recent analysis, the average household will have to pay $1,398 in additional taxes every year for the next 30 years to fund retiree benefits, with New Jersey taxpayers on the hook for $2,475 per year per household before that state's recent reforms.?Even more optimistic commentators recognize that the funding ratios reported by states themselves rely on rosy assumptions about investment returns that are not likely to be borne out in reality.?Consequently, states have begun to adjust contribution rates, close loopholes, and otherwise modify pension and retiree healthcare benefits.

It is worth noting that most of these reforms leave public-sector workers, especially those newly-hired, worse off. In many states, this is a necessary evil, with budgets straining and taxes being ratcheted ever higher. Some states have done better than others in making fundamental reforms to address the sustainability of workers' benefits without soaking new workers or taxpayers, however. Here are our best and worst of the year so far, recognizing that actions in New York and Connecticut are still pending. Thanks to our indefatigable research intern, Josh Pierson, for digging up some of the details on states' reforms.

Best:

  • Arizona: Senate Bill 1614?increases teachers' contributions to the Arizona State Retirement System, saving the state $39 million in FY 2012. Senate Bill 1609 modifies the "rule of 85" retirement option (effectively raising the retirement age), requires "double dipping" retired workers to contribute more to the pension system, and limits the amount of service time teachers can buy in the retirement system to increase their pension payouts. Teachers were excluded (for better or worse) from a provision that reduces cost of living adjustments when the retirement fund fails to hit its investment targets. Most importantly, the state will study adding a defined contribution plan for its workers.
  • Indiana: Senate Bill 524 creates a defined contribution retirement option for new state workers, teachers included. Workers will pay 3% of their salaries into the system, and school districts will pay the same amount they currently pay into the defined benefit plan.
  • New Jersey: The Garden State's reforms are the most sweeping enacted this year by far. Senate Bill 2937 increased teachers' contributions to their pensions and bumped the retirement age up to 65, but it also gives workers a contractual right to their employers' contributions to the system. This means they can sue if their employer fails to pay up. Even more importantly, the bill addresses one of NJ's biggest problems, its largely unfunded skyrocketing health care costs. The reform package requires teachers to contribute meaningfully to their health care plans but also incentivizes school districts to develop cost-saving health care alternatives, passing on some of the savings to their workers.

Worst:

  • Hawaii: The state's schools have been in a notoriously bad financial state, famously prompting them to close one day a week in recent years. House Bill 1035 freezes benefits increases until the state retirement system is 100% funded. So far, so good. Except the bill funds the shortfall on the backs of new workers and taxpayers; existing employees are exempted from any increases in contributions.
  • North Dakota: Senate Bill 2108 increases employee contributions to 12.3% and employer contributions to 18.7%. Do the math: 30% of every worker's salary goes to the pension system, far above the norm for workers in either the public or private sector.
  • Oklahoma: The Sooner State's retirement system is only 48% funded, so legislators came up with a novel way to close the gap: pretend it isn't really there. House Bill 2132 changes how cost of living adjustments are classified, switching them to a "pay as you go" model instead of saving for them ahead of time. Voila ? the system went to 56% funded overnight! On paper, at least. OK taxpayers will likely have to pay up for those cost of living increases in the end, though.

Our takeaway from this year's reforms is that many state legislatures and school boards should go back to the drawing board. Move new workers to portable, defined-contribution or cash balance retirement schemes, and put an end to retiree health benefits funded entirely by employers, the costs of which are exploding and which very few private-sector workers enjoy. Use any savings to improve the raises teachers receive in their first few years on the job, when research suggests they make the biggest gains in effectiveness. Continuing to steal from younger and more mobile workers while reducing their benefits is not a viable option and is certain to make teaching less attractive to high performers.

? Chris Tessone

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