First and foremost, any federal action on state and municipal pensions must include an expansion of ERISA – the law that requires private sector pension systems to properly fund their obligations on an annual basis. Those underfunded systems that can’t meet the ERISA terms and needing a bailout would then be subject to the following requirements:
1. Close under-funded pension plans to new salary dollars. Pension systems deep in a hole must first stop digging, in this case by closing the pension fund to new salary obligations. Pensions on existing salary dollars would be protected and continue to earn years of service. Employers could award new raises, but the increments of the raise would be non-pensionable (although could be eligible for other compliant retirement plans). Often it is local employers who award late-career raises (which drive up pension obligations) but states who then must pay the pensions. Edunomics Lab analysis shows that California’s CALSTRS plan would have over $16B less in obligations if such a requirement had been imposed 10 years ago (even after accounting for what would be lower employee contributions).
2. Pay for any bailout with a federal tax on pension payments from systems needing rescue funds. In places like Illinois, leaders pledged to unsustainable pensions, ignored their debts, and paid more in salaries (further driving up pension debt). Leaders in other locales, like neighboring Wisconsin, followed a path of fiscal prudence and paid its debts, even when doing so has meant teachers earn $10K less per year. So, who should own Illinois’ pension tab?
Illinois’ TRS fund needs a bailout, and while Illinois leaders haven’t been able to legally modify the generous pensions it promised, the federal government can tax those payments. The tax could take the form of a flat or progressive rate, collected by the pension fund via a monthly withdrawal from pension checks. Where a retired teacher earns $130,000 per year from the Illinois TRS (and yes, plenty do), the payments could be taxed before they ever reach the retiree. Such a tax would only last as long as the fund needed bailing.
This plan gives states the tools they need to get back on track financially without passing the debt burden to younger generations who neither benefitted from the spending nor had no say in the decisions that got us here.