Skip Navigation

The Leaflet: Reducing COLAs to Bring Pension Costs Down

September 1, 2017

This week's Leaflet examines how states can address pension costs through cost of living adjustments reform.

Many states are providing to state workers automatic cost of living adjustments (COLAs), raising governments’ costs and forcing taxpayers to pay more for the same services. COLAs aren’t only applied to current workers earning government wages. For many pension plans, the benefits received are increased periodically to reflect inflation and the increased cost of living. While COLAs are common in the public sector workplace, in the private market, they are not automatic and only given when funds are available.

COLAs create problems for some states because in many pension systems, they are implemented automatically, regardless of the government’s ability to pay for them. As the number of retirees grows, a funding gap increases over time.

The rapidly increasing cost of state pensions and the market decline that occurred in the wake of the 2009-10 housing crash caused numerous states to reduce or eliminate their COLAs for many of their employees. Between 2009 and 2015, 29 states reduced COLAs. Seven of those states reduced COLAs for current employees and new hires. Sixteen states reduced COLAs only for current employees. Just five states reduced COLAs for new hires only.

Many of the states changing their COLA rules had a fixed guarantee of 2.5–3.5 percent compounded annually. This guarantee created a cost of living adjustment for workers and/or retirees regardless of what was happening to inflation, spurring unsustainable growth of state workers’ retirement benefits and making it nearly impossible for states to maintain a stable pension over the long term.

Lowering COLA can have a dramatic effect on pension liabilities, according to the Mercatus Center; a 1-percentage-point reduction in annual COLAs would reduce a plan’s accrued liability by approximately 10 percent.

There are several options states can pursue to help manage their COLAs. First, states can eliminate COLAs for all or a portion of retirees. New Jersey, Oklahoma, and Rhode Island have taken this route. New Jersey and Rhode Island suspended their COLAs in their pension plans until the plans are 80 percent funded. New Jersey would then require a committee to reactive COLAs, while Rhode Island would tie the COLA to investment performance in the future. Oklahoma took a different path. It required its COLAs to be prefunded at the time of enactment, making implementing a COLA policy difficult.

The second option for states is linking COLA increases to the Consumer Price Index (CPI). Several states have done this, and a smaller number have done so while also implementing a cap. When inflation is low, this method has a minimal effect on pension holders, but it also does little to help the basic pension funding problem. This method is also problematic because CPI is a flawed mechanism in its own right; it only measures the cost of private goods and services, not public goods, and it also lags behind real-world consumer trends.

Richard Ebeling argues CPI has an even more fundamental flaw: “[A]ny price index, whether the CPI or the PCE, are statistical constructions created by economists and statisticians that have very little to do with the actions and decisions of consumers and producers in the everyday affairs of market demand and supply.”If a state cannot move away from a CPI-linked COLA, it should either cap the COLA or keep it as low as possible.

Eliminating or reducing COLAs are a viable option for bringing down pension costs for states, because it is one of the few pension reforms that have consistently passed legal muster. According to the Center for Retirement Research (CRR), of the 17 states that have reduced COLAs, 12 have been challenged in court, and in the nine cases the courts have ruled on, only one cut was struck down. CRR says that for many courts, COLAs are not considered to be a contractual right and can be reduced by the state.

Taxpayers cannot afford for states to continue overpromising and underfunding their pension plans. States should consider reducing COLAs or ending automatic COLAs outright.

What We're Working On

Budget & Tax
Roadmap for the 21st Century: Rightsizing Government: Reduce Spending and Restore Growth
This Roadmap paper, the 10th and final in the Roadmap for the 21st Century series by Peter Ferrara and Lewis Uhler, discusses the need to reduce spending and restore economic growth by “rightsizing” the national government. “Up to a point, every dollar spent ... adds more than a dollar to the nation’s gross domestic product (GDP) by facilitating and protecting commerce and investment. ... Government spending more than this optimal level detracts from economic growth and general prosperity,” wrote Ferrara and Uhler. Read more

Education
Research & Commentary: Universal ESAs Would Make West Virginia a National Leader in Education Choice
West Virginia is currently considering a proposal that would establish a universal education savings account (ESA) program. If passed, ESAs would be available to parents of public school children to pay for tuition and fees at private and parochial schools. The funds could also be used to pay for textbooks, tutoring services, transportation costs, computers and other approved hardware, online courses, dual-enrollment courses, and educational therapies and services. Additionally, the ESAs could be used to cover the fees required to take national standardized achievement tests, such as the SAT or ACT, or to pay for tuition and fees at a technical college. In this Research & Commentary, Policy Analyst Tim Benson wrote, “Establishing a universal ESA program would put the Mountain State at the forefront of the education choice movement and would give all Georgia families a greater opportunity to meet each child’s unique education needs. When parents are given the opportunity to choose, every school must compete and improve, which gives more children the opportunity to attend a quality school.” Read more

Energy & Environment
Research & Commentary: Banning Fracking in Florida Would Be a Mistake
Proposals have been introduced in the Florida Legislature that would permanently ban hydraulic fracturing, commonly called “fracking,” in the Sunshine State. Opposition to fracking in Florida stems partly from environmental concerns over the possibility the process could contaminate the Everglades National Park or groundwater in the Floridan or Biscayne aquifers, which provide drinking water to most of the state’s population. In this Research & Commentary, Policy Analyst Tim Benson writes enacting a permanent ban on fracking in Florida would be a costly mistake because the existing peer-reviewed evidence shows hydraulic fracturing processes do not pose a systemic impact on groundwater. Federal, state, and local governments have tested thousands of sites for hydraulic fracturing pollution of groundwater and drinking water resources, and “drilling is currently being conducted in Florida in a safe and responsible manner,” wrote Benson. Read more

Health Care
Heartland Daily Podcast: Hal Scherz: Repeal Obamacare and CON Laws, Protect Direct Primary Care
While most eyes are now looking to Washington, DC regarding the fate of the Affordable Care Act, there are steps state legislators can take to improve the cost and availability of health care in their states. In this edition of the Heartland Daily Podcast, Dr. Hal Scherz, founder and secretary of the Docs4PatientCare Foundation and host of The Doctor’s Lounge radio show, joined Health Care News Managing Editor Michael Hamilton in this episode of the Heartland Daily Podcast to make the case for state lawmakers preempting federal government health care reforms. Read more

From Our Free-Market Friends
The Liberty Leadership Council Announced!
Are you or someone you know interested in joining a networking group that educates young professionals on current Texas policy issues and fosters meaningful relationships within your city? If so, the Texas Public Policy Foundation’s Liberty Leadership Council might be for you! The Liberty Leadership Council (LLC) was launched in 2016 in Austin, Houston, and Midland with the goal of equipping and empowering young people to advance principles of individual liberty, personal responsibility, and free enterprise. If you are interested in learning more about LLC, please sign up here.


 

Author
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance. In 2012, Glans was named senior policy analyst.
mglans@heartland.org @HeartlandGR