Michigan’s Legislature is considering a bill to change the default option for members of the state-managed school retirement system from a 401(k)-style plan to a pension option. This change will put the state at further risk of deeper pension debt. Lawmakers should not put more people in a system that lets the state promise benefits now and pay for them later.
The state already owes billions more than it has saved to pay for the pension benefits of public school and community college employees. It never asked school employees to lend this money to the state. Instead, state officials failed to put in enough money to pay for benefits.
This happened despite a constitutional requirement to prefund benefits. The state is required to pay for the pensions earned by employees as they are earned by Article IX, Section 24 of the state constitution. And it is required so that, “our children will not, 50 years hence, suffer from the fact that we failed to put in enough money,” as one constitutional delegate put it.
Even with that obligation, lawmakers have broad authority to decide how much to save for pensions. They typically choose methods that underfund the system. Indeed, the system has had enough money to pay for earned pensions in just a single year over the past 49 years. The pension system has not been funded, it’s been underfunded.
These deficits add up. Right now, pensioners are owed $35.1 billion more than has been saved. In contrast, the state owes its bondholders $24.9 billion. In other words, the state owes pensioners in this system — who aren’t even state employees — much more than the people who willingly lent the state money. It accidentally made school employees the state’s largest creditors. That’s bad for teachers and taxpayers alike.
Pension debts are large and matter to school employees, public school administrators and taxpayers. The benefits cost 48% of school payroll, and 80% of the payments go to paying down pension system debts, rather than paying for what current employees earn. Lawmakers could pump a lot more money into today’s classrooms — or let taxpayers keep more of what they earn — if they hadn’t gone so far into debt for last year’s classrooms.
Lawmakers have done a lot to limit the ability to promise benefits now and pay for them later. One way that pensions have been underfunded is that bad assumptions were used to prefund pensions. Legislators are now using better assumptions.
Another has been to give new employees the option to choose between a 401(k)-style plan and a conventional pension plan. Even the conventional pension plan offered is a little bit different since employees who choose it take responsibility for paying down half of any pension debts that arise.
The latest proposed legislation would put new employees into that pension plan as a default option. Assuming that this would lead more people to take this option, the change would increase the risk of underfunding both to employees and to the state. This newest pension option has not been underfunded so far, but there aren’t any retirees claiming benefits from the plan yet. Offering new tiers of benefits has been tried before, however, and every one of the previous tiers has been underfunded.
The state has perennially underfunded pensions. Legislators should be careful about increasing the incentives to continue this practice. They should avoid creating new temptations for themselves or their successors to lowball pension costs. They should keep the 401(k)-style plan as the default option, because these benefits must be paid as they are earned, which is a constitutional requirement Michigan’s policymakers have repeatedly failed to meet.
Permission to reprint this blog post in whole or in part is hereby granted, provided that the author (or authors) and the Mackinac Center for Public Policy are properly cited.
Get insightful commentary and the most reliable research on Michigan issues sent straight to your inbox.
The Mackinac Center for Public Policy is a nonprofit research and educational institute that advances the principles of free markets and limited government. Through our research and education programs, we challenge government overreach and advocate for a free-market approach to public policy that frees people to realize their potential and dreams.
Please consider contributing to our work to advance a freer and more prosperous state.