Ed Lotterman: Two sides to military pension cutback

December 27, 2013 

A little-noted feature of the recent budget bill, together with wrangling in many states over public employee pensions, raises a question that has economic implications as well as legal and moral ones: Are defined-benefit pension plans explicit contracts of compensation for work performed and, for military and public safety personnel, perils undergone?

Or are they a voluntary favor granted by employers as a gesture of gratitude that can be withdrawn at any minute?

The military pension question is the one most currently in the news. The budget compromise includes a provision that reduces the annual cost-of-living increase for those retiring from active duty. Through 2014, the current system will remain in force; its annual cost-of-living increases are based on the same consumer price index used to adjust Social Security.

But starting in 2015, for military retirees in a certain age bracket, the adjustment will be 1 percentage point less than this CPI increase.

It will start at retirement and continue each year until retirees reach age 62. At that point, their payments will jump up to what they would have been if they had gotten the full increase each year. And they will increase by the full change in CPI from then on. Since 20 years of service is the threshold for retirement, many career military personnel retire in their early 40s. The new law will mean two decades of slightly lower income. Some estimates are that this cut has a present value of $50,000 or so for retiring sergeants and more for officers.

There is no grandfathering, of people already retired but under age 62 or those with many years of service and about to retire.

Many past proposals for military retirement overhaul included a provision that the changes apply only for those with less than 12 or 14 years of service at the time of the change and not anyone with more years. The argument was that since retirement at half-pay after 20 years had been the rule for so long, it constituted implicit payment for service already performed. Jerking that away would be considered reneging on a contract.

That was not ironclad, however. For decades, retiree pay went up whenever Congress increased active-duty pay. All retired sergeants first class with the same length of service got exactly the same percentage of current active pay during retirement, regardless of the calendar year in which they had retired. And whenever active pay went up, so did their retirement check by the same proportion.

But in the 1970s, this was changed to the current system of a retiree’s initial pension being based on prevailing military pay, but subsequently increasing annually by the CPI.

There similarly was no grandfathering. So as the pay increases necessary to attract recruits to an all-volunteer force outstripped increases in the CPI, any sergeants first class who retired in 1980 got a substantially bigger check than one with identical service who had retired a decade earlier.

Similarly, there long was a system of retiring at the pay of “highest grade held.” Anyone who had held a temporary wartime commission retired at that level. And anyone who got a promotion could then retire almost immediately. In the 1990s, that was changed to retirement based on highest three years. Again, there was no grandfathering.

In both cases, certain individuals were disadvantaged and they certainly grumped about it. But a few legal challenges never got past the first hearing. The law and precedent are clear. This week’s cut clearly is legal even if many think it unfair.

Affected retirees, numbered in the hundreds of thousands, correctly argue that an implicit tax has been imposed on them while all other citizens, including Wall Street hedge funds managers enjoying the “carried interest” scam, face no higher taxes. This is correct.

Whether it is an injustice is a matter of opinion. As a military reserve retiree who started to draw a retirement check at age 60, I sympathize with those who argue that there should have been some degree of grandfathering. But as an economist, it is clear that would have reduced immediate budget savings to zero for another decade.

Moreover, we have an asymmetric system in which no one ever objects to increases in implicit compensation, even while they howl at small cuts.

Military retiree health care is an example. For many decades, the only benefit was access to military base medical facilities on a space-available basis. If you retired near Fort Bragg or Lackland Air Force Base, you could get treatment on post. If you retired by a lake in Minnesota, far from any active-duty base, you were out of luck.

That was changed starting in the 1970s, and medical benefits for retirees became progressively better, including the extension of the current Tricare system to reservists like me.

Setting aside legal and moral considerations, what are the economic ones? On the plus side, there is a modest benefit to the budget, some $600 million per year. On the negative side, this effectively is a slight pay cut.

“Welcome to the real world,” say the millions of employees of telecommunications or auto companies, airlines and other private businesses whose pensions were flushed away.

These businesses are still able to get the workers they currently need and so will the Department of Defense and any state governments that cut back benefits.

The upshot is that we need thoughtful, comprehensive overhauls in the compensation of the military and state and local governments. This isn’t it, but it isn’t the end of the world, either.

Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.

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