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Three ways that politicians are storing up disaster for pensioners

Starving, spiking and smoothing are short-term fixes that guarantee long-term problems

September 4, 2014 6:00AM ET

From coast to coast, Democrats and Republicans appear united in devastating what remains of traditional pensions in America.

Through three basic strategies — smoothing, spiking and starving — politicians can burnish their images as public benefactors today, but only by inflating future costs and risks that will slam society after their careers are over.

Voters, workers and taxpayers whose time horizon is more than the next election cycle need to police their politicians now, or they and their progeny will bear a terrible burden later.

The economics of pensions

First, some clarification about pension economics: There are two basic types of pension plans. A defined-benefit pension plan pools money from the paychecks of many workers so it can be invested to provide future benefits.

This traditional type of plan does have its flaws. Politicians can manipulate this system in many ways, including reducing how much is set aside today and who gets paid to manage the pooled funds. But these shortcomings pale in comparison to the newer defined-contribution retirement savings plans, which are much more expensive, much less efficient and far less reliable.

We have centuries of experience with traditional pensions. There’s no mystery about how much to set aside and how to invest it smartly so people collect in old age until their time runs out.

Contrast this track record with 401(k) and Individual Retirement Accounts, or IRAs.  Because these are individual accounts, costs are high. For example, Exxon Mobil spends just $200 managing each $1 million in its traditional pension plan, while many individual plans cost $10,000 per million or 50 times as much.

Traditional pension plans are efficient because they require only a small reserve, thanks to the law of large numbers. If the average life expectancy of everyone in the plan is, say, 85, then only enough money is needed to pay benefits to that age.

However, an individual does not know how long he or she will live, so saving to average life expectancy is foolhardy.  On the other hand, saving to age 100, or the maximum life span of 116 assumed in IRS tables, requires setting aside much more money during working years than to the average life expectancy of a large group.

Those extra savings mean spending less today, reducing happiness. Multiplied by the tens of millions of people forced to save more it also means a reduction in the total amount of goods and services people can buy, which reduces economic growth and jobs.

Politicians also want to spend money today and defer the costs into the future. Playing with pensions turns out to be a convenient way to do this, because so few people understand the simple economics.

Three ways to cheat pensions

There are three basic ways politicians cheat pensions: smoothing, starving and spiking. Smoothing is the polite term for putting less money into a pension plan than is prudent.

President Barack Obama and members of Congress in both parties engaged in smoothing by agreeing last month to let corporations reduce the amount of money they put into their pension plans. That will increase corporate profits, which means larger corporate income tax revenues. The extra revenues will be used to keep the federal Highway Trust Fund from going broke this fall, which would have thrown construction workers into the unemployment lines.

When the real costs of pension smoothing hit, some time after 2025, you can expect big companies to plead for relief from Washington.

Obama and congressional Democrats went along with this deceptive policy because Republicans refused to consider raising the federal excise tax on gasoline and diesel fuel. Since its last increase, in 1993, inflation has reduced its value by almost 40 percent while construction costs have continued to rise.

Under federal budget rules the real costs of the pension smoothing become invisible because make-up contributions are more than 10 years into the future. When the real costs hit, some time after 2025, you can expect big companies to plead for relief from Washington. More pensions will also fail, dumping the costs onto the federal Pension Benefit Guarantee Corporation, an insurer whose obligations ultimately fall to taxpayers.

The second ploy is spiking, in which public sector workers artificially inflate their income in the last year or sometimes last day on the job. Most traditional pensions pay out based on the average earnings of the last five years in the job.

More than two decades ago I wrote an exposé of police officers, career public managers and the closely related city council members of a small Florida town, who all collected huge pensions by inflating, or spiking, their last paychecks. One Los Angeles County official, in his last year, turned in his county car, took no vacation and dropped his health plan to boost his cash pay, resulting in a pension much larger than his gross paycheck.

Since then many state and local governments have moved to limit or prevent pension spiking. Phoenix, Ariz., put an end to pension spiking this summer after its municipal pension costs grew from $7.2 million in 2003 to $130 million this year. The association representing police sergeants and lieutenants then filed suit, asserting they had a right to their grossly inflated pensions.

CalPERS, the California state public worker pension plan, recently added 99 new ways to spike pension benefits even though the pension pool already does not have enough resources to pay all the benefits earned to date. The spiking bonanza drew a sharp rebuke from Gov. Jerry Brown, a Democrat, but he does not have the power to undo the damage. The California legislature, with both chambers controlled by Democrats, appears unlikely to buck public employee union leaders, who curry support from their members by encouraging spiking.

Christie’s betrayal

The worst stratagem for cutting pensions is starvation. New Jersey put no state money into its public employee pension plan in 15 of the last 20 years under governors from both parties, even though local governments found ways to make the required payments and balance their budgets.

Gov. Chris Christie, a Republican who hopes to become president, made fixing this mess his signature financial issue. He ran for election, and then a second term, with a plan to put billions of dollars into the pension pool, making up a significant share of the shortfall.

But then, without telling anyone, Christie began cutting back on the flow of money into the pension pool. Now he proposes severely under-funding. That will only end in disaster for the workers and taxpayers, but not until years after his career will likely come to an end, even if he wins the White House.

At the same time, Christie has steered contracts to manage the pension pool money to political supporters, as thoroughly documented by journalist David Sirota, prompting scathing news, columns and editorials in a number of Garden State newspapers. Christie dismissed Sirota as incompetent, but misdescribed what he wrote and did not offer any evidence that he erred.

Smoothing, spiking and starving are three words voters, taxpayers and workers should watch for in the news because they all add up to future disaster — not prudently investing money today equals huge increases in tomorrow’s burdens.

David Cay Johnston, an investigative reporter who won a Pulitzer Prize while at The New York Times, teaches business, tax and property law of the ancient world at the Syracuse University College of Law. He is the best-selling author of “Perfectly Legal,” “Free Lunch” and “The Fine Print” and the editor of the new anthology “Divided: The Perils of Our Growing Inequality.”

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera America's editorial policy.

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