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By Arnold Bock with Lorimer Wilson
Public
sector employees, the workforce 'elite' led by state and municipal workers,
are now storming legislative chambers to preserve their special status.
Wisconsin is the current case study in what happens when the government, a
monopoly service provider, confronts the fact that the taxpayer is tapped out
and can't take it anymore - when there simply isn't enough money. Those
realities are going to result in major adjustments in worker incomes,
future pensions and benefits and their overall standard of living. Let me
explain.
Why State and Municipal Governments are in Financial Trouble
As
odd as it may seem, state and local governments, are in even worse financial
shape than the federal government with its parabolic deficits and accumulated
debt. The reasons are that:
a) States and municipalities don't have the franchise to create money through
entering digits on a computer screen or running the printing press.
'Quantitative Easing' is the exclusive prerogative of the federal government.
States and municipalities must, by law, balance their operating budgets
although capital expenditures can be financed through the sale of bonds,
assuming buyers can be found to accept the interest rates offered and the
inherent risks of owning such securities.
The
crisis in state and municipal debt is real with insolvency and financial
collapse near for many. According to Northwestern University's Kellogg School
of Management, pension underfunding of municipalities currently totals $574 Billion.
States are much worse off in terms of their underfunded employee pensions to
the tune of $3.3 Trillion.
b)
States and municipalities are suffering from unrestrained spending on
salaries and wages, health care benefits and pensions of their employees. The
single largest component of budgets is the salaries and benefits of the
employees. As a case in point, it costs the City of Milwaukee 74.2 cents
extra for every single dollar of wages it pays its public school teachers and
other employees as compared to the additional 24.3 cents that similar private
sector employees receive... a whopping 205.3% more! With income disparity
like that is it any wonder that the 'workforce elites' in America today are
public sector employees?
Precious
few coddled private sector workers remain who share the special status
enjoyed by public sector workers. General Motors and Chrysler are recent
examples of what happens to private sector workers whose total compensation
package becomes bloated beyond reason. Predictably, they ultimately faced the
realities and judgement of a marketplace where
competitors with better products, services, price and choice prevail. While
the federal government bailed out both the companies and their UAW employees,
the magnitude of state and municipal debt is much more overwhelming.
Not
all municipalities and states are the same and they are certainly different
from their private sector counterparts. One obvious difference, for example,
is that 36.8 percent of all government employees in the U.S. are unionized,
while only 6.9 percent of private sector workers carry union credentials.
How Public Sector Salaries and Benefits Got So Over-the-Top
Government
employees can credit their special status on:
- their
monopoly position as service providers,
- their union
muscle,
- the fact that
their employer also had the deep pocketed taxpayer in its corner until
now,
- the current
electoral process, and
- the
manner in which "fair and equitable" contract settlements have
been negotiated.
Public
sector unions have increasingly developed alliances with candidates and
political parties. Vast quantities of campaign cash, as well as paid and
volunteer help from public sector workers, have cemented mutually productive
relationships with many of their elected employers. President Obama's
election and recent intervention in the Wisconsin conflict pretty much
explains which party has been the primary beneficiary this electoral grease.
Hence the quid pro quo when wages and benefits are on the negotiating table.
Because
of the multiplicity of state and municipal jurisdictions, all performing
similar functions, it is only normal for salary and benefits to be compared.
Pattern-setting settlements of salaries and benefits achieved by strong
unions, among compliant employers, are regularly cited as the benchmark for
'fair and equitable' settlements in many other jurisdictions. Frequently, the
pattern-setting leaders are those states and municipalities with histories of
strong unions and 'established partnerships' with their elected decision
makers.
Often
a much more subtle set of circumstances prevail. Designated executives and
managers excluded from the bargaining unit are usually in charge of
'negotiations' with representatives of the broader workforce. Since it would
not be considered fair for the salary and benefit increases of the non-union
and executive employees to be less, in percentage terms, than those awarded
workers more junior in the pecking order, there is a built-in bias to higher
wage and benefit settlements for the broader group of employees. Hard-nosed
confrontational bargaining definitely isn't the norm. Yes, there is plenty of
public posturing, but out of sight, the relationship is much more collegial -
for mutual benefit.
Passively
allowing union negotiators to 'win' at the bargaining table provides an
automatic 'push' for the subsequent executive and management compensation
package. Even more effective is designing and/or exploiting a process by
which labour tribunals are used and 'acceptable'
arbitrators are appointed to award favourable judgements to the employees. When decisions run counter
to reason, common sense and are beyond the financial capacity of the state or
municipality, politicians and executives in charge of the process throw their
hands up in feigned dismay and frustration claiming that there was nothing
that could be done to alter the outcome. The consequence is a 'sweetheart
deal' to the benefit of everyone - except the taxpayer.
Why Many Public Sector Pension Plans are Under-funded
As
the workforce ages, pensions and health care benefits have come to the fore,
especially seriously underfunded and unfunded liabilities of pension plans.
In the past, excessively favourable pension
provisions and underfunding were seldom discussed. They were considered to be
problems for the distant future to be dealt with on someone else's watch. But
the future is now. No longer can decision makers extend and pretend. Delaying
and praying won't help either. What is real is that many, maybe a majority,
of public sector pensions are underfunded. Why?
a) Unwarranted Assumptions: The actuaries hired by fund
managers and politicians made unwarranted and exceptionally optimistic
assumptions about rates of inflation, investment returns, interest rates,
salary levels and other relevant facts, which provided the answers the law
demanded and the persons signing the consulting contract wanted to hear. This
process is reminiscent of the prevailing practice of bond evaluators who
placed AAA investment grade ratings on rancid Wall Street financial
derivatives. The pension plans in the states of New Jersey and Illinois,
among others, were regular beneficiaries of these deceptions.
b) Back-end Loading of Incomes: Another example of unprincipled
self-dealing on the public sector pension front is the practice of 'spiking'
one's income during the last year, or years, of employment. The intent is to
build the base upon which the retirement pension is calculated. Obtaining
generous overtime assignments and receiving payment for accumulated, but
unused, sick pay has a similar and most salutary effect on the pension. Since
many employees leave with a full pension after thirty years of employment and
a minimum of fifty years of age, they can be expected to draw their pension
for thirty years after which their spouse can draw approximately half of the
pension for their remaining years.
c) Inflation Adjustments: There is another significant perk
which most non-government employees, and those without defined benefit
pensions, are unfamiliar. It is called 'inflation adjustment' or COLA (Cost
Of Living Adjustment). It means that the public sector defined benefit
pension is adjusted upwards each year to reflect increases in the Consumer
Price Index. Aside from protection against price inflation, this provision
allows much psychic certainty for the duration of the retirement period
leading to considerable peace of mind for the lucky public sector pensioner.
d) Subsidized Contributions: Many, but definitely not all,
government employee defined benefit pension provisions come almost free of
charge - to the employee. During the years of employment many employee plans
do not require the employee to pay for any or only part of their benefits,
although others do. Many defined benefit pension plans use a matching formula
where the employer and the employee make equal contributions.
e) Free Health Insurance Premiums: These are
frequently treated in a similar manner as pensions whereby the employer pays
the entire cost, or the contributions are matched equally between both
employer and employee. After retiring, the benefits continue but without
further contributions by the retiree. The period between a retirement age in
the low 50's and the retiree's eligibility for Medicare at age 65 represents
a very expensive period for the public sector employer.
What Under-funded Pensions Mean for the Future
Where
does this discussion lead? What are the conclusions? What does it mean to
state and local governments? What effect does it have on the taxpaying
public?
Certain
states and municipalities have demonstrated responsible long term financial
planning, especially as it relates to funding pensions and benefits for their
employees. They have funded their future obligations based on honest formulas
and assumptions. The employee was an equal partner in contributing to the
costs. Pension and benefit provisions - and enhancements - were not
implemented without appreciating the essential role of the taxpayer in the
period ahead. However, such prudent planning and management was not carried
out across the board by many municipalities and states. As mentioned above, a
massive financial brick wall of underfunded pensions lies directly ahead to
the tune of $574 billion and $3.3 trillion respectively.
The
fact of the matter is that the current weak economy, coupled with high
unemployment, an annual federal deficit of $1.6 Trillion (three times what it
was as recently as two years ago) and a balance sheet debt in excess of $14
Trillion, means that there is no federal money to bail out states and
municipalities. In addition, unfunded federal obligations for Social Security
and Medicare are somewhere north of $50 and up to $100 Trillion. The country
is insolvent...as in broke! The economy can't grow enough and the government
can't tax enough to make the deficit and debt crises disappear - or even
become manageable.
Conclusion
The
'tough love' we are beginning to see in New Jersey, New York, Wisconsin and
other states and municipalities is merely the tip of the proverbial iceberg. Externally
imposed constraint by bondholders and especially the taxpaying and voting
public will become the norm. Public sector workers everywhere will need to
accept the reality of:
- lower
incomes,
- lower
pensions,
- lower
benefits and
- lower
living standards.
These new realities are coming our way in the near
future. They cannot be circumvented. Public demonstrations by the aggrieved
public sector elite will not alter the abovementioned financial and economic
facts. Rather, they portray the end of gold-plated defined benefit pension
plans which have no regard for the taxpayers who foot the bill. It is either
that or a major revolution instigated by taxpayers.
Arnold Bock
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