Do pension reforms of the past three decades exacerbate income inequality? Does rising income inequality in turn dampen the economy? A new study from the National Conference on Public Employee Retirement Systems, a trade group based in Washington D.C., seeks to answer these questions.
The analysis found that income inequality was highly co-related with the trend toward conversion of defined benefit to defined contribution plans. The correlation between income inequality and percentage of workforce (public and private) covered by defined benefit plans was –.894. Calling the correlation “robust,” the study’s authors claim it means that the lower the percentage in the workforce with DB plans, the higher the income inequality. Other factors that had a robust inverse relationship with income inequality included changes in the percentage of the workforce in unions, marginal (top income) tax rates, and the rate of investment in public education. Inverse relations mean that higher income inequality is the result when the percentage of the workforce in unions; marginal tax rates; and the rate of investment in public education are all lower.
The analysis also examined the relationship between income inequality and economic growth. The analysis shows that this correlation was –.553. This simply means that the higher the income inequality, the lower is the economic growth. Other factors considered in the analysis included rate of investment in public education and multifactor productivity. Multifactor productivity refers to economic inputs including labor, capital, and raw materials.
Higher-level analysis of the national data using advanced multivariate techniques was not viable due to limitations of the available data. Yet the authors claim “it is clear from the empirical data from 1980s, 1990s, and 2000s that when DB plans are changed into DC plans, income inequality rises and economic growth dampens. Also, just by looking at the raw data one can conclude that if the trend toward conversion of DB into DC plans during the past 30 years did not exist, 15 million more US workers would be covered by a lifetime guarantee of a DB plan.”
The analysis found that the higher the number of negative pension changes made by a state government, the higher is the increase in income inequality in that state. Again, by negative changes they mean cuts in benefits, increases in employee contributions, and conversion of DB plans into DC or hybrid plans.
“The data show that the correlation between negative pension changes and income inequality during 2000–2010 was –.378. This correlation means that the more negative changes a state makes to its pension plan, the higher is the income inequality in that state. The state-level data allowed us to do advance multivariate analysis to examine the relationship between pension changes and income inequality and between income inequality and economic growth.”
The analysis shows that with a single negative change in pensions in a state, income inequality increases by 15 percent in that state. This relationship holds true even when other factors contributing to income inequality, such as lack of investment in education, are taken into account.
Next, the analysis examined the relationship between income inequality and economic growth in each of the 50 states during 2000–2010. The analysis shows that states with rising income inequality had slower economic growth. The analysis found that for each one-unit increase in income inequality in a state, the rate of economic growth in that state was reduced by about 18 percent. By one unit we mean the ratio of incomes of top and bottom quintiles changes by one. Again, this relationship holds true even when other factors affecting economic growth, such as productivity, are taken into account.
“Policymakers should pay serious attention to income inequality and its hidden economic cost to taxpayers before they make the changes that diminish DB pensions,” the study concludes. “Rather than making changes such as increasing employee contributions, cutting benefits, converting DB plans into DC or hybrid plans, and so forth, policymakers should close tax loopholes.”
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With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
