Taxpayer Backing? What Taxpayer Backing?

As Chicago Mayor Rahm “the Godfather” Emanuel recently emphasized in hardnosed bargaining with teachers unions, there is typically no enforceable taxpayer backing for public pension funds.

Yes, the promises of a public employee pension system are often viewed as contractual. But the laws creating “independent” pension fund systems expressly disclaim any guarantee by the state or any public employer that the fund will perform as promised. While public employers have liability for making contributions to the fund, there is no explicit guarantee that taxes will be raised or diverted from essential services to fund those contributions. If existing tax revenues preclude public employers from meeting contribution demands, and push comes to shove, the investment risk-taking of public pension funds will likely fall on current and future retirees.

Although political pressure has resulted in public employers making regular contributions to the fund, and threatens to induce public employers to raise taxes to make those contributions, the legal reality is that there is no reliable guarantee of taxpayer backing if public employers balk. This is because Arizona’s pension laws disclaim any guarantee that the pension fund will perform; they state that their terms are subject to change or repeal; there are numerous independent supermajority and referenda limits on the ability of the state and its political subdivisions to raise taxes, all of which simultaneously limit the ability of the trust fund to successfully compel a tax levy if contributions are not made; and employers and arguably the fund itself can file bankruptcy if they project insolvency within one year.

This point of law reveals the imprudence, if not fiduciary fraud, of public pension fund managers premising the solvency of public pension systems on high-flying rates of return. The fundamental financial problem with various guaranteed retirement benefit plans is that they have long assumed an average rate of return on investments not seen since the bubble years. Meeting that assumed rate of return has led public pension funds to pursue overly risky investments. And this behavior, in turn, has been based on the premise that there will always be taxpayer backing if the investment dice turn up snake-eyes.

This stack of assumptions is a house of cards. It underscores the need to transform the public pension system into one in which future employees control their own destiny by investing in the equivalent of 401(k) accounts—and to prepare for the very real possibility of pension fund bankruptcy for current employees and retirees as our nation heads into still greater economic uncertainty.

Learn More:

Chicagoist: Emanuel’s Pension Reform