Who’s Afraid of the Defined Contribution Plan?

Posted on by Joseph Haslag

The city of Springfield can’t keep going with the police and fire pension system it has in place. The unfunded liability has reached at least $197 million, and discussions are under way about filling that gap. But those efforts don’t address an equally critical question: Should Springfield continue to offer the same pension plan, switch to a plan in which both the city and employees contribute to a retirement savings account, or provide some combination of the two?

Change is always a little frightening. For decades, police and firefighters have been able to put in service time and leave with a pension. It has become so commonplace that it is treated as an entitlement. The problem is the defined benefit plan, which provides monthly retiree payments that are not related to employee contributions. But there is opportunity for change. Indeed, it is necessary for Springfield and other cities to put everything on the table.

As a starting point, Springfield officials should consider a defined contribution plan, in which employees are responsible for funding and managing their retirement accounts.

Defined contribution plans frequently attract two criticisms:

First, people live for varying lengths of time. Some die right after retirement, while others survive much longer, which means they could outlive their retirement funds. This criticism is a red herring. After retiring, it is easy to convert your retirement savings account to an annuity that makes monthly payments for life.

Second, in a defined benefit plan, city government bears the risk when financial markets realize price declines. When asset prices fall, the city’s obligation to retirees is unchanged: The assets backing the pension have fallen. Put another way, when asset prices fall, the pension payment stream stays the same, but the asset value isn’t large enough to support that stream. That’s when the city government’s unfunded liability balloons. In contrast, retirees own their savings accounts under a defined contribution plan. Retirees bear the risk when asset prices fall. So, pensions provide income security to future retirees while defined contribution plans offer no such guarantees.

But risk-bearing differences are not the end of the story. Labor markets work much better than that. Higher wages can offset the additional risk associated with defined contribution plans. There is a wage level that will compensate future police and firefighters enough for them to bear the additional risk associated with a defined contribution plan.

It would take a more detailed analysis to quantify a wage increase adequate to hire the necessary number of police and firefighters. Such quantitative evidence is essential for comparing defined benefit plans and defined contribution plans. It may be cheaper, in expected value terms, for the city to bear the risk, but the work should be done.

One additional risk has been ignored, and arguably is the most costly. When governments offer pensions to workers, there is a disconnect between workers’ contributions to their retirement benefits and the size of the benefits. Elected officials find it politically easy — and a boon to their reelection efforts — to raise retirement benefits. Because the post-retirement benefits are deferred, policymakers get an immediate political gain without facing the cost. Of course, this simply widens the gap between workers’ contributions and their post-retirement benefits. Think of the problems associated with Social Security. Worried about upsetting voters, policymakers are loath to impose the costs necessary to make the national pension plan solvent.

Finally, some point out that employees are more likely to switch jobs under defined contribution plans. This poses a problem for cities that spend a lot of money training firefighters and police officers. Just when those employees learn their jobs, they move on to greener pastures. But job mobility is part of a free society. I understand the desire to ensure a stable, well-trained force that protects people and their property. However, it is critical to note that market forces are always operating. If there is a shortage of experienced people, basic economics tells us that higher wage offers are available to deal with such a shortage. A defined benefit package is not an essential feature for cities trying to operate an effective fire department and a professional police force.

I am a big fan of defined contribution plans. I like them precisely because they are portable. In addition, there is a sense of personal responsibility for my retirement standard of living that I like; with tongue planted firmly in cheek, there is no federal bailout for university professors who do not provide for their old-age spending.

More seriously, the political realities are such that a defined-contribution-only plan is off the table. If so, I think it is best to try some kind of hybrid approach for future hires. Some defined contribution combined with a defined benefit program would provide some risk sharing, and would give the city the best chance to achieve predictable expenses. I also would suggest adding Social Security to the city’s defined benefit program.

The existing approach got Springfield into this situation. Some reform is needed to avoid the same problems in the future.

Joseph Haslag is executive vice president of the Show-Me Institute, a Missouri-based think tank, and a professor in economics at the University of Missouri–Columbia.

 

More Criticism of Smoking Ban

Posted on by Abhi Sivasailam

We’d like to highlight a recent letter written by Jim Winkelmann to the editor of the Post-Dispatch, discussing the smoking ban in Clayton. Winkelmann writes against what he sees as an erosion of civil liberties, and suggests that non-smokers have other avenues for recourse available to them beyond just legislation.

These arguments parallel ones made by our own policy analyst Dave Roland, on our blog, in testimony before the Clayton City Council, and to local media outlets.

Establishing Barriers to Entry in Archaeology

Posted on by Sarah Brodsky

This Post-Dispatch article quotes several archaeologists who are unhappy with a high school dig that’s taking place on private property. The teacher who’s supervising the work doesn’t have the credentials he would need if he wanted to use a federal grant. The criticisms look like a thinly veiled attempt to keep out competition:

Mark Raab, acting president of the Missouri Association of Professional Archaeologists, said he’s thrilled students are getting exposure to archaeology, but adds that the question lies in whether it’s being done to the highest professional standard.

Of course, any work done by high school students is not going to meet the highest professional standard. They’ve only recently started working in the field.

As for the teacher’s credentials, these students are fortunate to have a teacher with any archaeological training; it’s unreasonable to insist that a high school teacher study archaeology full time for 12 months straight, as the federally funded archaeologists are required to do. This teacher worked on excavations over two summers, when school was out. And there’s no guarantee that he would make better decisions if he had more degrees.

If every high school dig had to meet the most exacting standards, high schoolers simply wouldn’t be able to experience archaeology.

There are some cases in which allowing a lower standard for educational purposes is inappropriate. For example, I argued that people should not be allowed to own dangerous wild animals, even though restricting wildlife ownership to zoos will mean that some people miss out on opportunities to learn to care for the animals. The danger to other people outweighs the potential educational benefits.

But, in the case of the high school archaeological dig, the only ones who stand to lose from suboptimal work are the property owners — and they’re OK with it. If they want to call in top archaeologists, that’s their prerogative. And, if they want to turn the dig over to a teacher and his students, they’re free to do that.

The article puts it this way:

There is no standard process to follow if a high school group wants to dig on private property.

That’s how it should be.

Kansas City Should Learn From St. Louis’ Mistakes

Posted on by David Stokes

I don’t have much time to expand on this, because I have a flight to catch, but I see in the Kansas City Star that the city is beginning the process of studying the potential for a new downtown convention hotel. Reading the article — and even more so the comments telling Kansas City to do this and be a “big league city” — I got a sense of déjà vu. St. Louis went through every stage of this a decade ago, before a new downtown convention hotel was built with significant government involvement (i.e., tax credits, etc.). How has that worked out for St. Louis? Well, it is a very nice hotel, but it was recently sold on the courthouse steps to its creditors after it could not meet its bond obligations.

Kansas City should focus on creating a competitive environment for businesses. Then, if there is a real market for a new hotel, somebody will build it. If nobody steps up to do that, then there probably isn’t a market need to begin with. And, before you just assume that the hotel will attract all the new conventions necessary to pay for it, just remember that every single city in the world is planning for the exact same thing.

The Star’s editorial board struck the right tone for this issue a few weeks ago.

Your Tax Money Is in the Toilet (Literally)

Posted on by David Stokes

One of my favorite U.S senators, Tom Coburn of Oklahoma, has included a couple of Missouri pork/earmark/stimulus projects in his recent list of the 100 most wasteful stimulus projects in America. Today’s Springfield News-Leader has a story about spending a half-million federal dollars to replace 25 bathrooms in Mark Twain National Forest.

There were other questionable spending decisions in Missouri:

Coburn’s report also questions the need to spend $2.9 million to build a new visitor center at the Mingo National Wildlife Refuge near Poplar Bluff, $940,000 for solar power generation at a fish hatchery in Neosho and $500,000 in federal stimulus money to help defray costs for Missouri fish farmers.

It appears that Missouri’s fish farmers did quite well with the stimulus package, receiving two of the top 100 disbursements in Coburn’s list. They must have one heck of a lobbyist.

I have to admit, the new bathrooms look very nice. And I would have no problem with replacing a few of the old ones to make them accessible to the disabled. But do people really need 25 brand-new, nice toilets in the forest? Isn’t “roughing it” sort of the point of going to the Mark Twain National Forest?

The article reports that the contract was bid out, but I have to wonder exactly how high of a profit margin the contractors are getting. According to the article:

The original bid sought replacement of 22 toilets, but three more were added at no extra cost after park officials had a miscount of how many outhouses needed replaced, Cliff said.

That must have been one hell of a profit margin on the original bid, if the contractors are able to say they’ll gladly do 25 instead of 22 for the same amount of money. So, is this an example of wasteful government spending? I think the only appropriate answer is: “Does a bear s$*! in the woods?”

Thanks to Combest for the link.

Conflicting Headlines

Posted on by Sarah Brodsky

Combest lists some headlines related to the auto task force. Here’s one:

Auto jobs task force finalizing recommendations

And here’s another:

Auto task force begins analysis

So which is it? Are they getting started, or are they putting on the finishing touches? Maybe they just work really quickly.

Given that state planning of industries is economically disastrous, I hope they drag it out as long as possible. This shouldn’t be completed in a day.

CREDO Charter Study: Missouri an Outlier

Posted on by Josh Smith

The St. Louis Beacon and Kansas City Star both have stories about a recent study from Stanford University’s Center for Research on Education Outcomes that analyzes charter school performance nationwide, with specific results for Missouri. The news is not all good. According to the report, Missouri is one of only five states to show significantly higher learning rates in charter schools than in traditional public schools. According to the Beacon:

In other findings about Missouri, the report found that:

  • In general, new charter school students experience an initial drop in both reading and math compared to their counterparts in traditional public schools, but they experience no significant drop in reading and math in later years in charter schools.

  • In general, blacks and Hispanics in charter schools achieve significantly more in reading and math compared to their counterparts in public schools.

  • Poor students in charter schools perform significantly worse in both reading and math than their counterparts in traditional public schools.

  • Both special education students and English language learners receive no significant advantages from attending charter schools compared to their counterparts in traditional public schools.

So, according to this report, children in Missouri who attend charter schools experience an initial drop in reading and math, but later, reports the Star, “a Missouri student attending a charter school could expect to learn ‘significantly more in reading and math than they would if they went to a traditional public school in the same community.'”

This study is another data point to add to the case for charters. Nationwide, however, the study found that many individual charter students fared worse than comparable students in traditional schools.

The beauty of charter schools is that they are not all one beast. They offer a variety of options for different types of students, and students with different needs. Let’s relish the bad results as a learning opportunity for other charters, now and in the future, and relish the good results here in Missouri as a sign that charter schools offer a viable alternative to troubled traditional public schools.

I leave you with a statement from The National Alliance for Public Charter Schools, quoted in another article about the CREDO study:

“The CREDO report confirms what several other studies previously indicated: in states and communities where there are high standards for school quality and authorizers are performing their duties well, students in public charter schools are making solid academic progress. Where large numbers of schools have been created without a rigorous application process and adequate authorizer oversight, the results are unsatisfactory,” said Nelson Smith, president of the National Alliance for Public Charter Schools.

“We are encouraged by the ground-breaking results being achieved by many public charter schools across the country,” said Smith. “However, if high-quality performance is to become the norm for public charter schools, we need to ramp up our efforts to replicate what’s working as well as enhance our work to ‘remove the barriers to exit’ and make it easier to close chronically low-performing charters.”

The “Fair Tax” Rally In Columbia

Posted on by David Stokes

That twittering blogger himself, Mr. Combest, linked to a number of articles about the “Fair Tax” rally in Columbia this past weekend. I commend all the participants in the rally for getting out and fighting for a better tax system for our state’s economic growth. For an article about the proposal written by Dr. Rik Hafer — an economics professor with Southern Illinois University Edwardsville and a research fellow with the Show-Me Institute — check here.

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