The Brass Tax of Politics

The Great Wealth Switch: How the Public Sector Became Wealthy

People have traditionally measured wealth by the amount of tangible assets they have. Viewed from this perspective, many people who have saved substantially for their retirement through an IRA, a 401K, or other profit sharing plans, (all in the category known as defined contribution plans) are well up in the highest percentile of people with wealth. Other people have retirement plans that provide only income streams for their (and often their spouse’s) lives. These are known as defined benefit pension plans. But since they do not have a pool of assets in a separately owned account, having rights only to the income stream – they are not viewed as having actual assets.

Therefore, these people are very often at the low end of the “asset” wealth scale. But the income stream is certainly an asset, a quite valuable one. And because of government policy and other economic factors in the last few years, the value of the defined benefit plans has exploded compared to the value of defined contribution plans. This has created a massive wealth switch to public service employees from private sector employees.

Given what the federal government’s policy has been with interest rates and fiscal policy, and given the much lower rate of return we have had to endure these last 5 years, the value of the retirement income stream has grown enormously, while the value of the retirement “nest egg” has diminished correspondingly. In this way, there has been a real conversion of income and assets such that people with continual income streams from defined benefit plans can now be looked at as having substantial “assets” while the retirement portfolio earning very little interest is less desirable. Being considered “wealthy” has become more about with having financial security than assets. The main reason for this switch can be found by examining the state of the pension system.

Say you have two people — one person in private industry, and one in the public sector, both making say $70K/year and hoping and expecting that they could retire on, say, $50K per year for all their years of good service and hard work.

It used to be, up until about 5 years ago, that a private industry person retiring with that $50K/year plan in mind could actually retire on that. The sum of his portfolio that would enable him to retire with that much per year would be around $1 million .That person could reasonably have concluded that he is set pretty well for life; if his portfolio earns 5% a year, he could pull out that $50k a year (5-% on a $1 million ) and still have the principal ($1 million ) left to pass on to the kids.

In a similar way, a public service worker or union making the roughly the same money would have roughly similar expectations — a $50K yearly pension. You could put a value on it ($1 million) but there is a large difference between the public pension and private pension. When the public pensioner dies, that pension ends; the money is gone. That is, there is no principal because there is no personal “investment portfolio” in the same manner that a private sector pensioner has. The public pension is funded from the larger investment pool within the public service industry.

Now, the last five years has made the pension and investment situation for retirees quite untenable. Interest rates remain sluggish, yielding only around 2% a year. That becomes only about $20K in returns for the private industry person. Now the pensioner can’t live off of the returns from the million in his portfolio. It’s not going to give him the retirement he planned or the inheritance he thought he could pass on. He needs more.

The situation is different for the public service person. He still gets his $50k a year, regardless of whether the return is actually 2% or 5%. His defined benefit plan promised to pay him a set amount every year until he passes away. When these plans were funded, and interest rates were a reliable 5%, the public service employers were only putting away enough to have $1 million worth per person, counting on yearly investment returns of 5%.

In order for the public service pension to get funded as promised , (at $50K/yr) the public service pension pool must pay it. Though the plan may have been “worth” a $1 million, now that the pool has to cough up the difference in funds due to low investment performance (2% in reality when 5% was necessary). That pension now becomes the valued at $2.5 million, ($2.5million x 2% = $50,000) because more funds are needed to supplement it in order to maintain the promised payments.

The government must come up with that extra $1.5 million supplement to sustain the promised benefits to the public service person. Multiply that by for every person for which there is not enough money set aside in these pooled retirement funds to pay for them. Where does that money come from? The employer? No, the taxpayer.

Here’s the kicker. When the public sector and unions earmarked that million for the employee, they hoped it would be enough to cover it. Within the private sector, over time business owners began to understand the fiscal instability and risk inherent in such defined benefit plans. Refusing to make such a commitment, most private sector employers have abandoned such plans completely.

When the public service sector started seeing the fissures in the system, they started to negotiate to keep their benefits as good as possible. But they didn’t, and still don’t, negotiate with the taxpayer. They negotiate with politicians, not the people who fund the retirement pool.

So what has really happened with these public and private retirement plans? Those public service persons with the $50K retirement plan saw the value of their retirement jump from $1 million to $2.5 million. From an accounting point of view, it’s money going into the assets of the public service employees, while the other side is a debt born to all the taxpayers for the benefit of a few.

This is nothing more than a huge wealth transfer. When the public sector and unions made deals with municipalities, these were cozy sweetheart deals, a trojan horse, a poison pill. There were no provisions made to handle the possibility of a low-interest rate society; they took their chances and their fallback was to suck money from the taxpayer by raising taxes to cover budgeting shortfalls.

Now the private sector pensioners are bearing the brunt on two fronts — their own retirement plans are performing poorly and their portfolios are dwindling while their taxes help to fund the gross negligence of the public sector. All taxpayers are feeling the pinch. The failure of the public service groups to be responsible in their fiduciary responsibility to the taxpayer means that now more than ever, vast amounts of wealth are being given over merely to band-aid this broken system, mask the true debt, and avoid real reform. This is politician/public service union cronyism for all to see.

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  1. Thanks for this piece. I had not thought of it this way but I do think you are right….and unfortunately, I think we are a looooong way from recovery. With interest rates staying at drastic lows, our investments are sluggish and our retirement accounts are being squeezed. Not sure what to do about it.

  2. Said another way: Slash pensions in excess of $25,000 per year down to size. The taxpayer should NOT be on the hook for those. $25,000 per year for 30 years = $750,000 payout PER EMPLOYEE. Plenty of cash coming out the taxpayer’s bank account. Now do the math on 6 digit pensions for the police and fire “chiefs” that retire at under age 50.

  3. A perfect quote regarding public employee pension grants: “This takes place in a totally political atmosphere, without any regard for how the bill will be paid, by whom, and when” – Michigan state representative, Dan Angel.

    All public employee unions must be eliminated. FDR and many other leaders saw the danger in this, but politicians since see only the benefits to them in the form of a captive constituency.

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