Combating Moral Hazard: The Case for Rationalizing Public Employee Benefits

Abstract:     
The current crisis in public employee benefits is a fairly conventional moral hazard story about overly generous promises made by both private sector employers and politicians spending public dollars. The private sector, forced by the Financial Accounting Standards Board (FASB) in 1993 to confront the true cost of promises made to future retirees, dealt with the newly discovered debt in a number of ways, including the termination of defined benefit plans which were quickly replaced by defined contribution plans. The public sector was also forced to confront its own largesse with the implementation of GASB 45 which focused careful attention on the present value of the level of benefits promised. This period of scrutiny coincided with skyrocketing health care costs and a deep recession that saw enormous private sector job loss and, unsurprisingly, growing resentment by private sector employees of the relatively lavish benefits still enjoyed by unionized public workers. This paper describes the astonishing scope of public sector benefits-driven indebtedness and provides an account which contrasts the prudent self-correction process in the private sector with the ongoing struggle of many states to address the issue. In addition, the paper proposes specific reforms - the movement of all employees into DC plans, mandated use of realistic rates of return, the explicit promotion of the cultural norms of thrift and frugality, and, in extreme cases where the political landscape appears incapable of responding effectively to the crisis, the modification of legal regimes to prohibit collective bargaining over benefits - for policy makers to consider.

Number of Pages in PDF File: 68

Keywords: public sector unions, moral hazard, defined benefits pensions, defined contribution pensions, GASB 45, FAS 106, FASB, retiree heath care, Financial Accounting Standards Board, Governmental Accounting Standards Board

JEL Classification: K31, K39

Accepted Paper Series