Get it out of the office

Getting medical insurance out of the workplace would have been a grand idea. But bowing to practicality, the Obama administration pushed through a good-enough plan that leaves it there.

Let’s not make the same mistake twice when it comes to pensions. America and its retirees are facing a multi-dimensional pension crisis—one that, even more than health-care, requires severing the connection between the workplace and the social safety net.

Like health insurance, employer-provided pensions are regarded as the natural course of things in this country, but it wasn’t always so. It all started during World War II, when the government clamped down on wages. Benefits were a way of getting around the restrictions to increase compensation, but they persisted for good reasons. Paying workers with benefits rather than cash had tax advantages, and promising something 30 years into the future is always more appealing to employers than paying higher wages today.

But the system has bred serious problems, all of them getting larger by the day. First, individuals and their employers are terrible retirement planners. Companies have every incentive to make rosy assumptions that let them under-fund their plans, while employees, increasingly left to their own devices with 401(k)s and other such self-funded plans, probably don’t save enough.

Then there’s the problem of investing. Neither employers nor employees are very good at managing the money they do save. As Yeva Nersisyan and Levy Senior Scholar L. Randall Wray have shown, from 2007 to 2008, private pensions and IRAs lost roughly $2.9 trillion that people were counting on for their old age.

Defined-benefit plans—the nice, old-fashioned kind funded by employers—may have made sense when workers stayed put for years. Nowadays, though, people change jobs a lot more often and through no fault of their own. Employees fall victim to technology or downsizing every day. Yet vesting requirements persist, which means that these days more and more of your work-life won’t get you much pension credit.

If you have a company-funded plan, you also have to worry about whether your employer will remain in business—for if it goes bust, the plan often does as well, because there is not yet enough money to cover foreseeable obligations.

Workers are mostly protected from this risk by the federal Pension Benefit Guarantee Corp.—with the result that Uncle Sam is on the hook for perhaps $2.5 trillion in pension guarantees. To cover defaults, the agency charges employers insurance premiums (around $1.5 billion in 2008) that unfortunately amount to a tax on prudence, since healthy firms are forced to pay for failures. (For more on the PBGC, see this report.)

The sums are never enough anyway, and so the agency is running multi-billion dollar deficits. Make no mistake: although it’s supposed to be self-funding, PBGC would have to be bailed out by the taxpayers if it truly ran out of money—which it would only do at a time when the government was already under financial stress from a downward-spiraling economy.

Private pension liabilities are as large as they because the current system encourages—indeed, subsidizes—extravagant promises. Employers are always prone to be more generous when the payout is decades away, a problem we have in spades when we turn to the public sector, where pension liabilities for government employees threaten to swamp state budgets.

The desire for labor peace—and the political clout of public-employee unions—have led to pension promises taxpayers simply can’t afford. Shortfalls in this arena have been exacerbated by the financial crisis and the resulting recession, which delivered a one-two punch of falling investments and plummeting tax revenues. In New Jersey alone, the pension shortfall for government employees is $46 billion, according to the Hall Institute of Public Policy.

Bad as private pensions are, they are better than nothing. Sadly, the General Accounting Office reports, half of private-sector workers aren’t covered by any pension plan at all—except Social Security.

And therein lies the answer to our pension troubles. To eliminate investment risk, under-saving, unrealistic promises and taxpayer liability, all we have to do is sweep away the whole mess and raise the employer share of Social Security taxes by an equivalent amount.

These funds would become direct liabilities of Uncle Sam, just like Treasury bonds, thereby eliminating investment expenses or the risk of losing your retirement in the stock market. Set at the right amount, the tax would eliminate the problem of under-saving for most people. The incentive to make extravagant promises to workers would vanish. Yet the cost to workers—and employers—need not be any greater than the cost of fully-funded private pensions.

Americans are naturally wary of government, which may be one reason that employer-based pensions have persisted. But now that companies are handing this problem off to workers (in the form of self-funded plans), and now that workers have lived through some devastating investment losses, isn’t it time to try the kind of plan that works in so many other countries?

The funny thing is, it’s the same plan that’s worked here for decades. It’s called Social Security. We just need more of it.