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Policy Makers Should Consider Long-Term Impacts on Economy Before Making Cuts to Pensions
New research from NCPERS finds that policies that reduce pension benefits or promote transitions to defined contribution plans may end up costing even more due to the dynamic interrelationship between pension reforms, income inequality, the economy, and market returns.
By: Hank Kim, NCPERSWhen budgets are tight, policy makers often face tough decisions about cutting services, delaying projects, raising taxes, or even reducing public servants' benefits. But when it comes to closing pension plans or slashing benefits to save money in the short term, policy makers need to think twice: New research from NCPERS finds that policies that reduce pension benefits or promote transitions to defined contribution plans may end up costing even more due to the dynamic interrelationship between pension reforms, income inequality, the economy, and market returns.
The study, The Hidden Costs of Pension Reforms: Rising Income Inequality, Lagging Economic Growth, examines the relationship between pension reforms (consisting primarily of benefit reductions) in both the private and public sector, income inequality, and economic growth.
Between 1977-2021, the share of the US workforce covered by pension plans fell 13 percentage points while income inequality nearly doubled. In 1977, the top income quintile earned only 7 times the amount of the bottom quintile, while in 2021 they made almost 14 times more.
In the last four years alone, the world's five richest men more than doubled their wealth—from $405 billion to $869 billion—while nearly five billion people became poorer. As income inequality has steadily increased, not only has the American Dream gotten further and further out of reach for many, but our economy has been dampened.
Rising income inequality reduces growth in GDP by 2 to 4 percentage points annually, and it is inversely related to economic growth. From 2000-2020, when income inequality (defined as the ratio of top to bottom income quintiles) rose by one unit in a state, the annual rate of economic growth fell by 2 percent.
When the economy is depressed, market returns decline. This in turn suppresses the growth of the pooled assets invested in pension funds, reducing returns and ultimately costing plan sponsors (and taxpayers) more. This is especially important for policy makers to consider, since public pensions are net revenue positive for state and local economies.
In order to isolate the impact of reducing pension benefits or access, the study's lead researcher Dr. Michael Kahn examined other variables that impact income inequality, including the lack of investment in public education, regressive taxation, and a decline in union membership. The analysis found that each of these variables has an inverse relationship with income inequality.
Historically, many policy makers have made cuts to pensions and embraced regressive taxation models with the idea that economic benefits will ‘trickle down.' However, this new research makes a powerful statement about the dangers of this approach and the risks we face with rising income inequality. “By broadening access to pensions, instituting a progressive tax framework, or promoting workers' right to organize, we can help increase income equality and ultimately create a positive ‘trickle up' economic effect,” said Kahn.
On July 10th, NCPERS will host a webinar to review the findings of this new study. Kahn will be joined by Josh Bivens, chief economist at the Economic Policy Institute, to further discuss the connection between access to pensions, income equality, and economic growth. Register here to join this important conversation.
Please don't hesitate to reach out to info@ncpers.org with any questions about NCPERS research or our upcoming educational events.
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