Regarding your latest podcast on falling US govt yields. What [will be the] affect on government salaries and pensions?
Long-time government workers receive much better pay and retirement packages than new hires
The changes (degradation) to the pay and retirement packages in the government sector are gradual and subtle, and many of these adjustments to the total pay packages and benefits are more like small cuts that add up over the years. I also observe that many jobs have been shifting to private contractors. These employers offer lower wages and benefits and over time I find this a viable path for all levels of government. Government services of all kinds will be shifted to the private sector.
I know many federal workers across a number of departments and they tend to be long-term employees. As crazy as this may sound to some people, I have friends who are federal employees in their 50s and 60s and earn about $150,000 a year. I have tenants who work for the federal government and earn between $80,000 and $150,000 a year.
I know a federal worker in his early 60’s who has been with the Feds for over 30 years. He missed out on the defined benefit plans the Feds used to offer its employees, but his defined contribution package is much more superior than the one offered to later hires. He has almost $2 million in his job-related retirement accounts. Not bad. Good luck to the new hires.
I include the chart with the breakdown of federal employment by age as it shows the older age of the average federal employee. When a person is hired by the federal government they receive a certain pay package with benefits, and these terms are generally in effect for as long as the person stays at the job or with the government. Thus, workers tend to stick around until they can no longer work, because as the years go on, the older employment contract terms are so much more superior to the terms for more recent hires. Since there is no set retirement age in most instances, federal employees are older, on average, than the general workforce. The people who are being hired now have inferior pay and benefit packages.
Since the early 80s, defined benefit plans were purposely phased out in favor of defined contribution plans
The phase out of defined benefit and pension plans began in earnest in the early 1980s, as the elites knew where the world was heading. TPTB needed to gradually lower interest rates over time to move their new world order agenda forward, and this long-term process of ever-lower interest rates continues today. In a world of low interest rates, it’s impossible to fund pension plans that are based on actuarial assumptions. Most private pension plans were established decades ago and most of the annuitants have already left the planet.
In 1981, the concepts of the 401(k) and defined contribution plan were formally established under IRC and were quickly embraced by the private and public sector on the federal level. These plans essentially transferred the risk to the employee from the employer and wiped away most potential future post-job termination employer obligations.
Many local government pension plans are at great risk of default
The rule of thumb here in the United States is this; the federal government offers superior salaries, while the state and local governments offer less pay, but extend decent pension benefits to fully vested employees. These pension plans are contractual in nature and are usually presented as a senior creditor in any type of default. But if the tax jurisdiction doesn’t have the ability to pay, there needs to be some sort of settlement. This often results in discounted benefits. We have heard of a number of cases where pension benefits were cut in lieu of government default, but they are still rare.
The typical local and state jurisdictions conceive their pension plans according to actuarial assumptions, but many effectively end up just being a pay-as-you-go system, as many around the country remain woefully underfunded. Many regulators turn a blind eye to this problem, because the tax jurisdiction could just stick the deficits to the tax payer. It happens often. If any private concern’s pension plan were as underfunded as what some on the local level are currently, they would run into serious problems under ERISA and PBGC rules
Well-funded tax jurisdictions like Fairfax County, VA will be able to fund future pension obligation, regardless of interest rates. The County could easily increase property, sales, and income taxes.
Poorly funded tax jurisdictions like what we see in Illinois or New Jersey will continue to feel the pressure from declining interest rates. I predict that many of these poorly funded state and local plans will have to be renegiotaited. I see no way around it.
The planners in most of the local tax jurisdictions around the country knew that lower rates were coming and have been greatly cutting back pension benefits to newer hires. It is essentially a race against time. State and local government plan sponsors hope to continue shifting future pension obligations to the employee via defined contribution plans.
I have a close friend with advanced degrees who has worked for the county for 24 years. She tells me she needs to work for 30 years to receive full pension benefits, but counts herself lucky. She will receive almost her full salary as her pension. She tells me the more recent hires receive a much more stripped down retirement package. Over time, the county hopes to continually extract itself from the shackles of pension obligations. But, like I said, it’s a race against time for many poorer counties and cities. The areas that can’t raise taxes much higher will have less options.
If a worker is employed by a poorly funded and managed jurisdiction, I would be very concerned. I wonder how states like New Jersey, California, and Illinois will be able to continue funding their plans. These public pension plans are essentially pay-as-you-go schemes, but that strategy can only sustain itself if the jurisdiction can raise taxes as needed. For many of these corrupt states, the limit is near. I would be very concerned if I lived in some of these areas.
So, to answer the original question of what will falling bond yields do to government salaries and pensions under a regime of low rates, I think the answer is somewhat straightforward. Salaries may hold up, but the back-end loaded pay like pensions will continue to get squeezed.