“The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increase on investment.”
Finally, economists Stephen Brown, Kathy Hayes and Lori Taylor examine the economic effects of fiscal policy of U.S. states. They find that:
“If anything, most public services do not appear to justify the taxes needed to finance them . . . this finding would seem to imply that other state and local public capital has been increased to the point of negative returns, perhaps because a growing stock of other public capital is indicative of an increasingly intrusive government.”
Option #2: Switch to Defined Contribution Systems
Rather than raising taxes, other states are moving away from the traditional defined benefit pension systems and towards a defined contribution system similar to the 401k system that is popular in the private sector. Currently, eleven states have moved to defined contributions in one of three ways with varying levels of cost savings. Connecticut should join this movement to reduce the long-term costs of the pension system.
First, the largest cost savings can be achieved by moving all new government employees into a defined contribution system. Currently, two states (Michigan in 1997 and Alaska in 2006) and the District of Columbia fall into this category.
Second, the next largest cost savings can be achieved by having both defined benefit and defined contribution systems. Currently, two states, Indiana and Oregon, fall into this category.
Finally, many states allow for their employees to choose between a defined benefit plan or a defined contribution plan. Depending on the specifics of each plan, there could be a lot of choice (both plans yielding very similar benefits) or very little choice (one plan yielding substantially greater benefits). As such, choice and, correspondingly, cost savings can vary by state. Currently, seven states (Washington, North Dakota, Montana, Florida, South Carolina, Ohio and Colorado) fall into this category.
Given Connecticut’s large unfunded pension liabilities, the state should go directly to the most effective option which is to follow in the footsteps of Michigan, Alaska and the District of Columbia. At the very least, putting new employees into a defined contribution plan will not add further to the unfunded pension liability. As long as the state meets its annual required contribution, normal turnover in the workforce will begin to bring down the unfunded pension liability to more manageable levels.
In the end, only two options are available to policy-makers to solve Connecticut’s pension
and OPEB crisis: 1) raise taxes; or 2) reform the pension and OPEB systems. Raising taxes would weaken Connecticut’s economy and jeopardize the state’s ability to ever meet its pension and OPEB obligations. The best option is to reform these systems by switching to a defined contribution program.
Without these reforms, state government will end up asking for greater sacrifices from citizens, such as higher taxes, to pay for the pension and OPEB benefits of government workers at levels that most citizens do not have themselves.
About the Yankee Institute For Public Policy
The Yankee Institute is a think tank that develops and advocates free-market and private sector solutions to public policy issues. Founded in 1984, Yankee has offices on the campus of Trinity College in Hartford, Connecticut. The Yankee Institute is a nonpartisan research and educational organization and is classified by the IRS as a 501 (c) (3) non-profit.