J. Scott Moody and
Wendy P. Warcholik, Ph.D.
Rio Grande Foundation
New Mexico’s defined benefit retirement system is massively underfunded. The pension system officially reports an unfunded liability of $4.6 billion; however, new analysis by two academic economists finds that the pension system is underfunded by at least $7.5 billion and may be as high as $22.9 billion—or three times greater than the state’s general obligation bond debt. The state Other Post Employment Benefits (OPEB) system, mostly health insurance, is underfunded by at least $2.9 billion.
Additionally, New Mexico’s state government, in FY 2008, was required to pay $948 million in contributions to the state’s pension and OPEB system — based on the lower, official unfunded liability estimate of $4.6 billion. Yet, the political will to meet even the very minimum obligation has been waning with the state’s FY 2008 contribution of only $663 million — leaving a shortfall of $285 million.
If the unfunded retiree liabilities are not dealt with soon, the annual required contributions to the retiree system will crowd-out other state spending such as roads and higher education. Fortunately, there are solutions which can be summarized by this straight-forward four-step process:
• Step 1: Fix the Public Sector Over-Employment Problem
In 2008, New Mexico’s state and local governments employed 25.3 people for every 100 people employed in the private sector versus the national average ratio of 16.72. If New Mexico’s state and local government ratio was reduced to the national average, then the workforce would be reduced by 56,970 people.
For every position eliminated, state and local governments would immediately save an average of $49,711 in compensation which includes wages and salaries as well as benefits. Overall, state and local governments could save up to $2,596,600,137 in annual budget savings.
More importantly, every position eliminated would create savings through reduced pension and retiree healthcare liabilities. A conservative estimate can be made by dividing the total pension and retiree healthcare liabilities (29.8 billion) by the total number of state and local government employees (167,671) which yields $178,001 in retiree benefit liabilities per employee (in today’s dollars).
One way to get at these employment savings is through a real hiring freeze which would gradually reduce employment levels through the normal turnover in the government workforce. This would also have to be accompanied by efforts to restructure the workforce to avoid having higher-value positions go unfilled just because the person in that position left.
• Step 2: Transform Defined Benefit System into a Defined Contribution System
Due to the unsustainable cost of the defined benefit pension system, more and more states have been moving towards a defined contribution system — similar to the 401k system. New Mexico should join this movement in order to reduce the long-term costs of the pension system. Currently, eleven states have moved to defined contributions with varying levels of cost savings.
Given New Mexico’s large unfunded pension liabilities, the state should follow the lead of Michigan, Alaska and the District of Columbia by having a defined contribution system for all new employees. At the very least, putting new employees into a defined contribution plan will not add to the unfunded pension liability.
• Step 3: Continue to Increase Employee/Retiree Contributions to the Retiree Healthcare System
During the 2009 legislative session, the Legislature enacted HB 351, which increased the employer and employee contributions to the retiree healthcare system to 3 percent from 1.95 percent phased-in over 4 years.
This is an important first step in correcting the unsustainable retiree healthcare system without resorting to tax increases or budgetary gimmicks. However, more reforms of this nature are needed since there are virtually no assets to offset the $3.1 billion unfunded retiree healthcare liability.
• Step 4: Expand the Private Sector
States with larger private sectors will grow faster over time than states with smaller private sectors. Finding ways to help New Mexico’s private sector grow is a win-win for both the public and private sector.
One low-cost, high-impact way to help the private sector is to perform a thorough review and culling of out-dated regulations.
In the end, a larger private sector will generate higher tax revenues which could be used to tackle New Mexico’s unfunded retiree system.
Without these changes, the state government will be in the awkward position of asking for greater sacrifices from citizens, such as higher taxes, to pay for the pension and retiree healthcare benefits of government workers at levels that most citizens themselves do not have. Not only is this bad public policy, it’s not fair.
J. Scott Moody and Wendy P. Warcholik, Ph,D are adjunct scholars with New Mexico’s Rio Grande Foundation. The Rio Grande Foundation is an independent, non-partisan, tax-exempt research and educational organization dedicated to promoting prosperity for New Mexico based on principles of limited government, economic freedom and individual responsibility.