Barro calls Raimondo-Chafee pension ideas ‘very promising’

Josh Barro knows pensions.

Barro, a senior fellow at the Manhattan Institute in New York City, is an expert on state and local finances and the author of “Dodging the Pension Disaster.” We spoke in May about how Rhode Island’s leaders should approach pension reform; on Friday, Barro emailed his thoughts on the ideas Treasurer Raimondo outlined today:

Overall, the plan laid out by Treasurer Raimondo and Governor Chafee strikes me as a very good approach.

It is particularly important that the new system is for all accruals by workers in the future – not just for workers not yet vested or not yet hired. This is very important so that the state can start achieving real savings quickly and stop awarding pension benefits that are larger than necessary to attract and retain workers. As you note, this mirrors the process for changing pension benefits that is typical in the private sector (in compliance with ERISA), but it has not been typical in the public sector; most states, to their detriment, have been enacting pension benefit reforms that do not apply to the current workforce, meaning that meaningful savings will not be realized for years or decades.

It will be important that the state makes the right decisions in structuring the hybrid pension plan. They should go with a hybrid that is stacked vertically – that is, workers accrue a defined benefit in proportion to the first part of their salary up to $x, and then a 401(k)-style benefit on dollars earned above that. This is a progressive system, ensuring that everybody receives a defined benefit that serves as a safety net, while higher-income workers are expected to take more responsibility for managing their own retirement.

The size of the defined benefit (DB) should be larger for workers outside Social Security than for those who participate in Social Security. (If designing the system myself, I would offer the DB only to workers not in Social Security, but it seems clear politically that there will have to be some DB component retained for everybody in Rhode Island.) And the defined benefit should use a Cash Balance Plan structure, to avoid creating perverse retention and retirement incentives – Cash Balance Plans, unlike traditional DB plans, have smooth accrual of benefits through a career, so they do not disadvantage workers with short careers in government and do not push people out the door after 30 years even if they would like to continue working.

Other options – such as a horizontal hybrid, where workers accrue a defined benefit and a 401(k) side by side, like in the Federal Employee Retirement System – would not provide as many advantages.

I also agree with Treasurer Raimondo about reamortization. By itself, reamortization does not save money, it just kicks the can down the road. But as part of an overall reform that achieves real reductions in the cost of pensions in Rhode Island, it is acceptable to reamortize the existing unfunded liability to spread out the pain of paying it off.

I do not love the COLA freeze. I find it somewhat strange that COLAs (not just in Rhode Island but elsewhere) tend to be viewed as a different kind of thing than other aspects of the benefit formula, such as the retirement age and the wage multiplier. Fundamentally, the COLA is just one part of the formula that determines the value of a pension, and adjusting the COLA takes away vested benefits. Taking away vested benefits is appropriate in cases of insolvency, as in Central Falls, but should generally be avoided.

But I understand why leaders are drawn to the COLA freeze – as Raimondo notes, it seems to be a relatively palatable way to save money, and many of the options that I think would be more appropriate tend to be off the table politically. So, if it’s the way out of this mess for Rhode Island, that’s OK with me.

So overall, I think this looks very promising.

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