IMPORTANT: It's a Serious Matter of Life

For municipal pensions, the political incentive is to underfund and over-promise

Pennsylvania is unique in having its local governments offer more than 1,400 retirement plans to public workers. While those municipal pension plans don’t drive up administrative costs, academic research has found an issue: When politicians get involved, the plans’ unfunded liabilities tend to increase due to political incentives.

Generous promises for future benefits can mask the tax burden that local taxpayers must carry.

“More politically competitive municipalities tend to have pension plans that are less funded,” Sutirtha Bagchi, an associate professor of economics at Villanova University, argued.

The problem comes from candidates trying to win elections.

“Competition for votes creates incentives for politicians from both parties to offer generous retirement benefits to workers in the public sector and simultaneously, to not fund them fully, in order to avoid raising taxes on workers in the private sector,” Bagchi wrote.

Voters usually aren’t combing through pension reports to gauge how realistic a plan’s financial assumptions are, so the full costs aren’t widely known.

“The status of the pension fund is typically not included in the government’s balance sheet, so state governments can ... make promises to people who are currently working…but they have a choice in terms of whether to fund them fully or not,” Bagchi said.

Politicians are “willing to make these promises which are very generous,” Bagchi said, but “these promises will come due at some point.”

Those promises can also conflict with state law.

In Allentown, the city’s police and firemen’s pension plans have been criticized by the auditor general for being out-of-compliance with state law, which could increase their pension costs, cause the state to overpay aid to the city, or lead to pension beneficiaries getting denied their promised benefits.

Despite previous audits that raised those issues with the city of Allentown, officials have yet to act on them, even though they do not dispute the auditor’s reports.

“Management further acknowledges that previous City responses to this finding (of non-compliance) have questioned the legal inconsistency of such provisions,” municipal officials noted in their audit response. “The City will abide by the provisions of its existing collective bargaining agreements and will aim through future bargaining agreements and amendments to City ordinances to harmonize the plan provisions with those of the Third Class City Code to the extent legally necessary and as quickly as possible.”

The difficulty of negotiating benefits in public-worker contracts complicates Allentown getting in compliance with the law. Even with the problems of local control, however, it isn’t likely to disappear in Pennsylvania.

“We love our local government and don’t like to get rid of local government,” Bagchi said.

The state government, however, could make some changes to limit the financial and legal problems that come from local control of municipal pensions. Bagchi mentioned more guidelines or strictures could be approved, or the Government Accounting Standards Board could pass more restrictive rules on what municipal pensions could offer.

There’s also the idea of removing elected officials from managing pensions and turning over the responsibilities to appointed officials.

Doing so “takes away the temptation of these elected officials – and it’s a very strong temptation – of basically getting a free lunch,” Bagchi said.

As Bagchi found in his research, when appointed officials manage funds instead of politicians, financial assumptions such as discount rates tend to be more realistic.

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