Barro: RI came closer than most but didn’t fix pension problem

There’s been a lot of pension triumphalism in Rhode Island since the overhaul of the state system masterminded by Treasurer Gina Raimondo was enacted by Governor Chafee and the General Assembly.

Josh Barro, a policy analyst at Bloomberg View, acknowledges that Rhode Island’s pension law is “the most aggressive reform of recent years.” But in a recent National Affairs article, he argues that even its “bold” changes “will not do enough to place the state’s pension system on sound financial footing.”

“Rhode Island still hasn’t been able to overcome the fundamental problems plaguing its pension system,” Barro writes, arguing that the Ocean State “came closer than any other state to success, and yet still couldn’t quite manage it.”

The heart of Barro’s critique is this: by keeping part of the pension plan as a defined benefit – a fixed annuity that’s paid regardless of actual investment returns – the new law still leaves taxpayers facing a significant risk if lawmakers don’t fund the system.

That critique would apply not only to Raimondo’s hybrid system but also to Providence Mayor Angel Taveras’s settlement, which keeps the traditional defined-benefit system in full and counts on future mayors and city councils to act responsibly if the city is to avoid another solvency crisis someday.

Here’s Barro:

Today … Rhode Islanders are in a mood for pension austerity, and further giveaways would not be popular (or affordable). But the fact that the state’s pension system has retained some part of its defined-benefit structure means that some day in the future — when the political and economic climates have become more favorable — legislators may well make unaffordable promises again. The very design of the system encourages such irresponsible behavior in good times, setting states up for yet more fiscal crises when the economy takes a turn for the worse.

In Barro’s words, “the underlying cause of the state’s pension problems has not been dealt with, and the potential for future mismanagement and funding problems remains.” In addition, he notes that the new system isn’t much cheaper than the old even one (although it’s costs are more predictable) and that the 36 locally run pension plans weren’t fixed.

Defenders of defined-benefit pensions counter Barro’s arguments in a number of ways.

First, as Raimondo and Boston College’s Alicia Munnell emphasized last year, the nationwide shift from defined-benefit pensions to 401k defined-contribution retirement plans has left many baby boomers without enough savings – in Raimondo’s words, they lack “retirement security.”

Second, defined-benefit plans are cheaper to administer than defined-contribution ones, according to economist Dean Baker: “This is a way to give a benefit that is of great value to workers (a guaranteed pension) at little cost to the state. I can’t see why it would want to throw this away.”

The problem with those arguments, Barro said in a interview last year, is that “defined-benefit pensions are basically a structure with which state lawmakers cannot be trusted. They involve making promises over periods of decades. They involve state lawmakers now making decisions for political benefit, and being able to send the bill to people who will be in office far in the future.”

In fairness to Rhode Island’s leaders, they didn’t ignore the risks outlined by Barro. (More on that in this post.) In the meantime, it’s possible all sides could unite behind at least one of the proposals in his article – changing federal law to force state governments to fund their pension plans:

With the enactment of the Employee Retirement Income Security Act (often referred to as ERISA) in 1974, the federal government started forcing private firms that offer defined-benefit pensions to maintain adequate funding ratios. …

The effect of ERISA was to make private defined-benefit pensions much more secure, but also more rare — a crucial point for the cause of state pension reform. While 38% of private-sector workers participated in a defined-benefit pension plan in 1980, the figure in 2008 was just 20%. Forced to incur the true cost of securely funding pension plans, many companies have chosen to abandon them in favor of 401(k) plans or similar defined-contribution models. The appeal of requiring states to abide by similar requirements is not just that they would no longer be able to shirk their obligations, but also that such requirements would make the advantages of defined-contribution pensions far clearer.

• Related: Barro: ‘Lawmakers cannot be trusted’ with today’s pension system (May 27, 2011)

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