Amid State Pension Funding Crises, Joining Social Security Becomes an Option

American retirement security, even prior to the Great Recession, was in bad shape. The downturn has only exacerbated previously-existing structural problems, such as an over-reliance on home values and the troubled transition from defined-benefit to defined-contribution retirement plans, as we mentioned in a previous Talking Points article. 

The retirement security crisis has become especially evident in public pension systems. Widespread underfunding during prosperous periods undermined the position of public pensions even before the unprecedented budget shortfalls states are now experiencing. Now most states, constitutionally committed to honoring their pension promises despite declining revenues and increasing pension envy from private sector workers, are looking for ways to decrease their vulnerability during downturns.

As shown in the map, thirteen states exclude some or most of their public workers from Social Security. Maine, which excludes most of its public employees and has underfunded its public pensions by over 30 percent of state GDP, has recently begun to look at shifting public workers into Social Security. The shift would be accompanied by a reduction in the state-sponsored pension benefit contributions to a level that would still provide equivalent retirement benefits for employees.

According to a task force report presented to Maine’s legislature in March 2010, there are two reasons Maine’s 124^th Legislature is considering the reform: inequitable allocation of pension benefits due to low portability of accrued contributions, and high vulnerability of the state’s pension systems during economic downturns.

The report states that less than half of state employees, including teachers, vest in the current pension system and less than 20 percent earn 25 years or more of benefits. Workers lose all employer contributions when they leave and withdraw contributions, and the retirement system therefore functions by reclaiming the lost benefits of employees who leave prior to vesting. Moving employees into Social Security would allow workers to accrue fully portable benefits, increasing the benefit coverage rate from 50 to 100 percent of employees, and allow additional pension benefits to remain retention incentives.

Currently, Maine excludes public workers from Social Security, and the state therefore bears the full risk of stock market downturns’ impacts on invested funds. This vulnerability has become starkly apparent during the Great Recession. So although the proposal of placing employees into Social Security would cost public employers more, as it would increase contributions from the current 5.5 percent of payroll to the Social Security rate of 6.2 percent, the state vastly reduces its exposure to market volatility.    

This vulnerability to market fluctuations makes a compelling case for putting all employees into Social Security, or indeed using Social Security as a vehicle to provide most if not all of the recommended 70-80 percent of pre-retirement income.  However, the problem with employee dependence upon Social Security for all retirement income is its weak income replacement capacity. Social Security provides, at most, just over 50 percent of pre-retirement income to low earners (although only 33 percent of their last year’s income level), yet low earners depend on Social Security for over 80 percent of their retirement income.  The replacement rates are lower yet for higher earners.

A movement of public workers into Social Security may help to do several things. First, it would protect both state budgets and workers’ retirement savings from market volatility even as it improves pension coverage and contribution rates. Second, the inclusion of public workers would expand the number of workers paying into the social security system and may therefore help ease some of the financial stresses associated with the retirement of baby boomers. This would, of course, have the greatest impact if the other thirteen states that exclude public workers also put their employees into the system.

Most interesting is the possibility that putting public workers into the system could change the politics of Social Security.   Specifically, the movement of unionized public sector workers into the federal system may bring the strength of Social Security under the umbrella of union agendas. Unions may, in turn, pressure the federal government to strengthen Social Security. Just as importantly, it would put public and private workers into the same boat, reducing pension envy and the political pressure to cut pension benefits. 

Maine’s proposal to put public workers into Social Security will not reduce current pension responsibilities, but it is a step in the direction of retirement security for all Americans.