Detroit has now filed for bankruptcy protection. The estimated cost of funding its pension obligations fully would be somewhere between $3.5 billion and $9.2 billion (Guardian article) though in fact the actual cost is not knowable (future interest rates and life expectancy for currently fairly young retirees being impossible to know for certain). The cost works out to an estimated maximum of $13,143 for every man, woman, and child currently living in Detroit. There are only about 225,000 people in Detroit who work (source) so the $9.2 billion estimate (from public employee unions) works out to about $41,000 per worker.
Unless you have a printing press for money and/or a direct connection to God who will tell you how long people are going to live and what return on investment can be expected 30 years from now, why would you promise to pay someone, e.g., $150,000 in today’s dollars starting 20 years from now and continuing until that person dies? Politicians seemingly cannot resist making these promises, however, so perhaps it is time to restrict their ability to do so. They are not, after all, actuarial experts. If insurance companies stuffed full of such experts are now having trouble meeting their annuity obligations (WSJ; nytimes) why would we expect politicians, motivated by a desire to get reelected, to do better?
Back in 2009 I wrote a review of a book covering the history of public employee unions and consequent pension commitments. Here we are four years later and one of America’s largest cities needs bankruptcy protection. Many of the rest (notably those whose populations are not growing) will follow into bankrtupcy if only their retirees can contrive to live a bit longer than expected and/or if interest rates remain low. Why would we want politicians to place those kinds of bets on our behalf?
We got to this point (with pension benefits) the same way we got to the huge national debt. It’s easier for politicians to kick the can down the road than it is to deal with the problem now. City/state employees threaten to strike if they don’t get a pay raise? Instead of raising taxes now (and pissing off voters) it’s easier for politicians to promise increased pension benefits in the future. They’ll be out of office by the time the debt comes due, so who cares 🙁
It’s easy for governments to promise defined-benefit pensions to their employees. It’s not like the folks making the promises have to come up with the money out of their own pockets. Hell, they don’t even have to come up with the money out of their own current budgets. Instead, they can use a promise that a hypothetical future mayor and council will tax hypothetical future residents in order to buy the loyalty of non-hypothetical current employees and voters. What’s not to like, from their perspective?
Of course, if they’re also fostering a culture so dysfunctional that the residents take a night out of the year specifically to light the city on fire…well, those hypothetical future residents might just end up STAYING hypothetical long past the point where the pension plan assumed they’d be actual people paying actual taxes.
Philip,
You wrote
“There are only about 225,000 people in Detroit who work, so the $9.2 billion estimate (from public employee unions) works out to about $41,000 per worker”
and your source writes
“What about Detroit’s current population? The Census Bureau estimates there are 563,055 people age 16 or older in the city who could potentially work and be part of the labor force. But only 54.3 percent of these are actually working, meaning they either have a job or are looking for one.”
What you wrote is somewhat misleading. I don’t live in Detroit, but I work there and I pay city income tax to the tune of 1% of my salary. You should be calculating, IMO, based on the total number of people working in the city, not just those who are residents.
Same can be said about businesses with self funded pension plans.
Fozbaca: True! The same book talks about how GM’s managers bankrupted the company with unwise pension guarantees. And then of course federal government bled taxpayers for nearly $100 billion to bail them out. But I don’t think there are that many companies left with defined-benefit plans. So the problem resolved itself in the private world.
John: I think you’re misreading the article. The 563,055 people “who could potentially work” are not working either in the city or in the suburbs. Most are simply not employed. The article says the following: “Another 257,576 of Detroit residents age 16 or older – 45.7 percent of that demographic – are not working. They do not have a job, and they are not looking for one.” The 225,000 figure might be off by 5-10% due to newer stats being available, people working for cash and not counted by the BLS, etc., but it isn’t off by a factor of 2.5X.
“why would you promise to pay someone, e.g., $150,000 in today’s dollars starting 20 years from now and continuing until that person dies?” because people are happy to believe that the promise will come true. In fact for a number of people the promised did, and currently does, come true. From a rational standpoint, why shouldn’t I vote for someone who gives me a large pension and early retirement age? I might get it. Yes, that’s not sure, but if I vote for someone who does not promise a large pension my chances of getting it are 0. We might argue that a smaller achievable pension is better that a large unachievable one. True. But how can I tell now what size of a pension could be achieved in the future? Basically it’s all a gamble, pension size notwithstanding. Obviously some people will lose, and what is going on in Detroit attests to that. But some people might win, and as long as there is a prize people will play.
I just got back from Russia. I met a fire chief in a small town (about 40,000 people) 37 years of service as a fire fighter in his community. He asked me what the retired fire chief in my city made per month. Since it was in the paper last year, I told him, $14,583. source It turns out he (Russian fire chief, with 10 more years experience on -job) gets a pension of $300/month. From the PFR website source it appears the law bans the use of pension money for non-pension budgetary expenses, pensions are mandatory for everyone. Maybe that is the solution? Make pensions mandatory and based upon contributions? Allow individuals to contribute there own money at their option to the fund? require municipal expenses to be less than receipts each year?
There is a bigger problem, compensation is a contractual obligation, I think we should simply set a limit to the contractual capabilities of government. i.e. government cannot enter into a binding contract that would last longer than X period of time. It isn’t like an individual where the individual will be the same in 20 years. BTW, I think the same is true for corporations.
Lets say that a corporation shouldn’t be able to enter into a contract longer than 15 years, I suggest that all terms of that contract would be required to be fulfilled within 15 years. Since a defined benefit pension is an unknown period of time, but definitely longer than 15 years, it would be an invalid contract.
Since the employees are working now, I believe they should be compensated within the foreseeable future. many companies have used bankruptcy as a way of overpromising and taking advantage of their employees, I would argue detroit has too. Even if the contract was made in good faith, it is clear that not all subsequent administrators share that good faith.
BTW, defined contribution plans work fine under this model, the contribution is made during the time the employee is under contract. I would say that for sure any compensation delivered as part of a contract should be fulfilled within the life of that contract, i.e. an employment contract should require all obligations to be fulfilled before that contract can be terminated. Again no defined benefit pensions. Which appear to be the equivalent of a unsecured loan. perhaps if companies paid rates similar to unsecured loans, these would be a thing of the past already, i.e. 10% annual interest on the benefit. we would then see qhat a joke these plans are for everyone involved.
Defined benefits are okay, as long as the employer pays for them completely and immediately upon them being earned, via purchasing them on the open market.
This also takes care of the “worked 30 shifts of overtime his last year on the job to bump up his ‘base’ salary” situations. The controls on current funds are a lot stricter than the controls on future promises.