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Retire This Rule

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Retire This Rule

Congress should block states from taking over the private-worker pension business. March 7, 2017
Economy, finance, and budgets
Politics and law

During President Obama’s eight years in office, the debt owed by public-worker retirement systems blasted from $650 billion to roughly $1.3 trillion. Even so, in the last year of his administration, Obama cleared the way for states to start operating new retirement systems for private-sector workers, too. Now advocates for these plans are leading a furious struggle to preserve them in the face of an effort by congressional Republicans to block the move by states into the market for private retirement systems. Some promoters of these new plans—which would automatically enroll private-sector workers without pensions in 401(k)-style accounts—are invoking the concept of states’ rights to argue that local governments are entitled to offer pensions free from Washington interference. It’s a dubious proposition at best from governments that have largely bungled their own worker-retirement systems.

About four years ago, state politicians began claiming that they could help solve America’s private-pension crisis by setting up plans for private-sector workers. California governor Jerry Brown has said that such plans “will enable more people to live with dignity in their retirement years.” In 2012, Brown signed a bill letting the state enroll workers at private firms that don’t offer pensions in a state-run system. California would automatically deduct contributions from paychecks unless the workers chose not to go into the plan. Since then, seven other states have enacted similar legislation; lawmakers have introduced comparable bills in about half of all states.

But California and other states also said they wouldn’t go ahead with these plans unless they got an exemption from the federal law that governs private pensions—The Employee Retirement Income Security Act of 1974, which sets minimum standards to which employers must adhere in designing and operating retirement plans. States wanted to be free to design their own rules and procedures, and so they petitioned the Obama administration, which, last August, granted state-government-run plans so-called safe harbor from ERISA.

Here’s what’s worrying. State-worker pension plans are already exempt from ERISA, which applies only to private employers, and states have made a mess out of their retirement plans.  Most state pension plans, for instance, use accounting standards that allow them to make far more optimistic calculations of their assets and liabilities than private plans can do under ERISA. One result: virtually all state pension plans have wound up overestimating their investment returns and hence have piled up debts. Indeed, three of the first states to pass legislation to set up new private-pension plans—California, Illinois, and Connecticut—have among the most deeply indebted government-worker retirement systems in the nation, collectively owing nearly $900 billion. Despite this mismanagement, the Obama administration said that it was confident that state governments could be expected to administer these new private plans.

Advocates argue that the proposed new retirement systems will be less risky than current government-employee pensions, which are largely defined-benefit plans that guarantee workers a certain annual income upon retirement. But many of the most indebted state-worker pensions were also originally designed to be “safe.” California’s pension law governing its state-worker systems, for instance, initially prohibited investments in risky assets like stocks and real estate. Over time, however, politicians changed the plan designs so that they could promise employees bigger retirement checks—eroding the protections originally built into them. There’s nothing preventing the same thing from happening with the new state-run retirement systems.

That some states told the Obama administration they wouldn’t create these new private-worker retirement systems unless they got an exemption from ERISA illustrates precisely why average citizens should be concerned. Among the requirements ERISA imposes on private employers: they can be legally liable to workers for mismanagement of their pensions. State politicians wanted “safe harbor” from ERISA so that they wouldn’t be subject to potential lawsuits from workers over these new plans.

The states’ ERISA exemption will almost certainly make them the biggest players in the American private-worker pension system, adding to the nearly $3.5 trillion in public-worker pension assets that states already control. An early study of California’s proposed private plan estimated that the Golden State alone would collect $7 billion in worker contributions in its first year. Many smaller firms that might otherwise offer pension plans to workers will almost certainly defer to the state plans rather than bearing the cost of starting their own.

With these concerns in mind, the House of Representatives has already passed a measure that would roll back the Obama administration rule. The fight now moves to the Senate, where supporters of the state plans are pressing Republicans to vote against repeal on the grounds that Congress shouldn’t “undermine states’ rights” to provide their own solutions to the retirement crisis, as Virginia representative Robert C. Scott argued on the House floor. But it hardly amounts to interference with states’ rights to demand that government-run retirement systems be held to the same standards that businesses must follow.

Washington has better alternatives than handing over much of the market for private pensions to state governments. Instead, it could change current retirement laws to make it easier for private firms to offer pensions. One option is to reform the so-called SIMPLE IRA, designed for firms with fewer than 100 employees, by reducing or eliminating the requirement that businesses must match up to 3 percent of employee contributions. (By contrast, IRAs in the proposed state-run plans impose no such requirement, making them more appealing to businesses that don’t want to be forced to make these payments.) The government could also consider ways to offer firms that implement their own IRAs greater tax credits to defer more of the administrative costs associated with these plans.

The Obama administration took the exact opposite approach. Even as it was telling states that they didn’t have to observe rules required of private employers, the administration imposed new strictures on financial advisers that are likely to raise the cost of running private-sector retirement plans. It’s almost as if Obama wanted to drive a big chunk of the country’s private-retirement system into the hands of government. Congress and President Trump should reverse course.

Photo by Scott Barbour/Getty Images

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