As most readers don’t check back on old Tax Update posts for comments (and bless you if you do), I’ll call attention to the back-and-forth between me and Pulitzer-prize winning tax beat writer David Cay Johnston on the merits and evils of defined benefit plans.
My view is that defined benefit plans are a time-bomb for government finance, as the actuarial games available to politicians and their confederates in public-employee unions are an irresistible temptation to understate liabilities and funding at the expense of future taxpayers. I cite the near-extinction of defined benefit plans in the private sector as evidence that they don’t work well.
Mr. Johnston insists that defined benefit plans work better in theory, and the problems they face in practice are just the work of evil administrators and poorly-designed regulations. It reminds me a little of the kids I knew in college who insisted that even though Communism had never worked so far, that’s only because it just hadn’t been done right.
By returning to the wise practices of the Happy Days era, where our parents happily drove to work for 40 years at the engine plant, DB boosters imply, we can again have secure monthly checks to help us buy our unfiltered cigarettes after retirement.
Except the golden age wasn’t. Megan McArdle points out that the nostalgia for DB plans is misplaced, pointing at this from Andrew Samwick:
My colleague Jon Skinner and I made that comparison in an article in the American Economic Review. The result was that the projected distributions of retirement income were surprisingly similar under the old-style DB plans that were dominant in the 1980s and the 401(k) plans that supplanted them in the 1990s, assuming workers were covered by the same plan over a long career. (The comparison was better for 401(k) plans when workers switched jobs — vested deferred benefits under DB plans are often quite low.)
In truth, this should not really come as a surprise. The amount of retirement income that will come from pensions is determined by workers’ willingness to give up current earnings for current pension contributions, regardless of whether they are making the contributions directly or the employer is (allegedly) contributing for them. If 401(k) plans are proving to be inadequate, it is because we are a nation of inadequate savers, not because we had a great system of DB pensions that we no longer have.
The problem, Samwick concludes, is not that we used to have fantastic defined benefit plans, and now we don’t–DB plans also take big hits when the market falls, and though they do have a government backstop which 401(k)s don’t, they also make a mid-career job loss utterly catastrophic. So there’s no clear winner on the security side.
Even under Mr. Johnston’s idealized scenario, DB plans only work with large stable employee bases. But the “dream” of getting a factory job out of high school and working at the same place for 40 years is a pipe dream in the modern economy, where changing jobs every few years is much more common than staying in place for a long time.
As for Mr. Johnston’s defense of such plans in the public sector, the unfolding public defined benefit pension disaster speaks for itself. It’s hard to find comfort in assurances that the theory works when the practice has been catastrophic.