Last week, the board that governs Baltimore County's employee pension system reduced its projection for investment return from 7.875 percent to 7.25 percent, a significant cut as these things go. The trustees of Maryland's much-larger pension plan considered a reduction as well but ultimately voted to keep a 7.75 percent estimate at a meeting Tuesday.
For a pension system to recalculate rate of return is hardly new. This is done periodically as the long-term economic outlook changes. But it's notable now because taxpayer unease with public pension programs has never been higher, and for good reason.
When a pension system lowers its expectations for income, something else has to give to keep the system's finances in good order, and that means either raising contributions or lowering benefits. In the case of Baltimore County, for instance, officials are planning for a $15 million increase in the county's pension contribution. Had the state lowered its forecast a mere one-quarter of 1 percent to 7.5 percent, the contribution might have increased $32 million per year. As it was, the trustees on Tuesday agreed to revise certain demographic assumptions about future benefits that are expected to cost the system $24 million next year.
Even in a multi-billion-dollar budget, this is not small change. And it's not as if government can afford to defer such costs. Rare is the public pension system that is fully funded. Maryland, like most states, currently falls well below the recommended pension funding goal of 80 percent, and investment returns for 2012 are unlikely to be anywhere close to 7.75 percent. California's pension system this week reported investment income closer to 1 percent.
Defined benefit pension plans for government employees have been a long tradition in this country. For many public sector beneficiaries, it is the reward for years of dedicated service for the often-modest wages offered for careers in state and local government.
But they also pose a considerable risk for taxpayers. A public pension system that can't meet its obligations can become a huge financial albatross for years to come. This is a major reason private sector pension plans have rapidly become an endangered species.
Last year, the Maryland General Assembly approved a "fix" that required both the state and its employees to contribute more to the $37 billion system and reduced benefits for future employees to help keep it solvent. Whether that patch was adequate to avoid future shortfalls is not clear (although it should be noted that over the past two years the investment return has been quite high, as the stocks and other portions of the investment portfolio rebounded).
What is clear is that what makes a pension so attractive to employees — the absence of risk — is what makes it so problematic for the employer left holding the bag. Another recession, and the pension system may find itself in a hole even deeper than what it faced a few years ago. The issue is not just poor investment returns but also higher costs as people live longer.
It shouldn't take a crisis to see the writing on the wall. While no current or retired state employee should have his or her retirement benefits yanked away, the status quo on government pensions is not enough — if only because the contrast with the private sector, home to most of the taxpayers who foot so much of the pension bill for those lucky government workers, has become so vast.
State and local governments need to gradually move their future employees from defined benefit plans to defined contribution plans — the equivalent of the private sector's 401(k) — where workers assume the risk and pensions are gradually phased out. Such cost-cutting is not easily done (witness the anger that developed in Wisconsin's pension fight) but it must be pursued.
Gov.Martin O'Malleyhas made it clear that he wishes to raise his national profile for a possible run for the White House in 2016. Challenging public employee unions, an important element of the Democratic base, would certainly accomplish this. Even more impressive would be to find a way to make a shift toward defined contribution plans in Maryland without causing a Wisconsin-like uproar.