The great train robbery; how the railroad retirement system swindles taxpayers, robs younger workers, and derails Amtrak.

The Great Train Robbery 

In America, the railroads have often been first: the nation's first $1 billion industry and the first way to get from New York to San Francisco without a horse. While many don't realize it, the railroads also led the way for a great liberal cause: old-age pensions. In the 19th century, the railroad industry initiated the nation's first widespread private pension plans, offering workers some semblance of security in their old age.

During the Great Depression, the railroads were again at the center of innovation. Congress took over the patchwork of private railroad pensions in 1934, a year before it established Social Security to protect the elderly nationwide. During congressional debate, one supporter promised that the railroad retirement system would become "a trail blazer.' Now, sadly, it's blazing a trail to bankruptcy.

To this day, railroad workers are not covered by Social Security but by this separate retirement system. This year, the federal government is pumping in $2.8 billion to keep railroad retirement afloat. In addition, railroad companies and their employees shoulder staggering payroll taxes. While workers covered by Social Security pay 7.15 percent of their income, railroad workers contribute 11.4 percent. The combined employer-employee payroll tax is 14.3 percent for workers covered by Social Security, compared to a mammoth 33.3 percent for the railroads. Even with this heavy taxation, the railroad retirement system's own actuary, in his most optimistic projection, predicts bankruptcy in 20 years. More likely, it's just a recession away.

These crippling payments are surely hastening the decline of America's railroads. With only one current employee for every three retiree, roughly one-sixth of the cost of moving freight by rail in this country now goes to pay benefits to those no longer working on the railroads. Largely because of our system of railroad retirement, it is now cheaper to haul coal to Brooklyn from Poland than it is from the mines of West Virginia.

The sad state of railroad pensions holds important lessons for reformers of other troubled funds like Medicare and Social Security. For decades, entrenched lobbies and their accomplices in Congress have pushed the costs of today's programs onto tomorrow's taxpayers. Like too many entitlements, railroad retirement shows how a worthy cause can be perverted by the politics of selfishness.

Racketeers, leeches, and moonshine 

The problems of the current system began as early as the 19th century, when the railroads established their own private pension plans. Instead of stockpiling reserves, they ladled out cash on a "pay-as-you-go' basis, paying current benefits out of current revenues. Money was not stockpiled for future costs. Within a generation, many of these programs were reeling with debt. For example, the Pennsylvania Railroad pension plan, begun in 1903 for less than $300,000, cost $3.5 million annually by 1925.

These kinds of expenses sparked an industry-wide crisis--even before the Great Depression. "How long can American Railroads stand the financial strain of their present pension plans?' asked the trade journal Railway Age in 1925. "What assurance has anyone that current revenues in 1950 will be sufficient to stand the strain of pension liabilities accruing in 1925?' As it turned out, there was no assurance at all. Those mismanaged private railroad pensions survived only because of federal intervention.

Interestingly, for years both management and labor leaders resisted a federal bailout. Management feared that a federal pension program would mean higher benefits for workers and higher taxes for them, a prediction that proved accurate. Meanwhile, rail union leaders opposed the idea for the same reason that Samuel Gompers and other union leaders initially opposed Social Security: they preferred pension plans with union leaders in charge of the till.

So a push for federal aid came from the rank and file, especially from the grassroots Railway Employee's Pension Association which was founded in 1929 to lobby for the plan. Led by W.W. Royster, the half-million members of the association confronted the powerful heads of the nation's 21 rail labor unions. It was tough going. "We have been assailed and held up to ridicule by our labor chiefs as racketeers . . . a leeches, and our endeavors referred to as inspired by moonshine,' said Royster, three years into the battle. As grassroots enthusiasm continued to swell, the union bosses finally relented and joined the fight for federal aid.

By 1934, labor was pressing Congress to pass the Railroad Retirement Act. They had history on their side. Congress had long used the railroads as a laboratory for progressive soical legislation. While the Supreme Court had struck down such legislation in other industries, the interstate commerce clause of the Constitution directly empowered Congress to regulate the railroads, and the Supreme Court let such legislation stand. Over the years, Congress granted rail workers the first eight-hour workday, collective bargaining, workman's compensation, generous severance pay and other benefits. Given this history--and Congressional interest in a pilot program to test Social Security--the bill to establish the federally run rail pension system had widespread support.

But its flaws were visible to more sober analysts. Franklin Roosevelt's coordinator of transportation, Joseph B. Eastman, urged its veto and set his staff of 2,000 to work on a fiscally sound retirement plan. Demographics made it no easy task; the railroads were already short on young employees and long on retirees.

Despite Eastman's warnings, pressure for the bill, sponsored by Sen. Robert Wagner, mounted. Wagner, the father-to-be of Social Security, leaned on FDR, reminding him that hundreds of thousands of his constituents wanted fast relief and hinting at the political consequences of denying them. "I do not know of any other measure during the past few years that has tied to it so greatly the hopes and sympathies of the great masses of working people,' he wrote in June, 1934. "To delay enactment over the summer would be most unfortunate.' FDR condemned the bill as "crudely drawn' and called it financially irresponsible. Then, grudgingly, he signed it.

Although the Supreme Court struck down the bill on a technicality, Congress found a way around the Court's objections. And this time, rail management dropped their objections to the bill when Congress agreed to assume all the liabilities of the carriers' foundering private pension plans.

Moonlight madness

The pension plan was a fine idea. Railroad workers, like the rest of us, need financial protection as they grow older and their earning power declines. But the benefits ought to bear some relation to financial reality. The Railroad Retirement Fund just doesn't.

Most private plans, for example, give retired employees 50 to 60 percent of their final takehome pay. In 1985, when the Labor Department surveyed 21 million workers in large and medium firms, it found no firm replaced more than 82.5 percent of their final take-home pay. That's miserly compared to most railroad workers, who are entitled to up to 125 percent of their final takehome pay.

How did railroad pensions become so bloated? The answer lies in the politics that all entitlement programs breed. As with Social Security and Medicare, the very existence of the system provided railroad retirees with added incentive to organize as a special interest. Competing unions and trade organizations get caught in bidding wars to deliver lucrative benefits.

Consider a payment called the "windfall benefit.' A perk of military and civil service retirement systems as well as the railroads, it allows those who work at a second job to collect the equivalent of two pensions. Say a railroad worker moonlights at a gas station. When he retires, he can collect Social Security for pumping gas and a railroad pension. What's more, the combination of these two pensions is substantially higher than if he worked exclusively under either system. That's because both systems favor workers with short-term employment and low earnings. It's double-dipping with an extra scoop.

In 1951, Congress eliminated this bonus, at the urging of both the carriers and labor leaders (who were then more responsive to their younger members). Still, mail flowed into Congress from retirees complaining about the cut. To lower the political heat, Congress raised overall railroad retirement benefits by 15 percent. Rank-and-file groups were not appeased; they prodded Congress into forming a special committee and restoring the benefit just a year later.

Finally, in 1974, Congress screwed up the courage to eliminate windfall benefits for workers retiring after that year. But by exempting retirees already on the rolls, it thrust an enormous burden on future taxpayers. Today, 35 percent of the nation's 954,000 railroad retirees reap windfall benefits, averaging $179 a month in addition to their other benefits. Not a king's ransom, but multiplied over a period of years it has become an extraordinary cost for taxpayers. To bear this cost, Congress has had to dip into general revenues, totaling about $275 million this year alone. The General Accounting Office estimates that taxpayers will have to shell out $3.3 billion in additional subsidies by the year 2000--just to fund one single benefit that has been denied to younger railroad workers for more than a decade.

Sympathy for the devil

Congress is bullied into these kind of expenses, in part, because so many retirees are convinced that they are entitled to them. "The great myth I hear all the time from the retirees is "I paid for these benefits,'' complains one rail union official. The average retiree draws $1,840 a month--exhausting his contributions during his first two years of retirement. Yet most speak of taxes as "contributions,' of benefits as "returns,' and of "reserves' building up in some mysterious "trust fund.' Of course, what the government is actually doing is taxing current employees and carriers and giving the money to retirees.

The rest of us pay too. Fully half of the system's revenues come from Social Security trust funds and the U.S. Treasury. According to the General Accounting Office, $38 billion in Social Security trust funds will be pumped into the railroad retirement system between now and the year 2000.

But while government dole-outs keep the system solvent, many retirees are convinced that the government is actually stealing their money. One prevalent rumor maintains that their retirement monies were raided to pay for the Marshall Plan. "The letters come in waves,' said Bill Poulous, a spokesman for the Railroad Retirement Board. Another rumor claims that the railroad pension funds paid for the resettlement of Vietnamese refugees. Effie Mae Smith, whose late husband worked for the Missouri Pacific and who now serves as secretary-treasurer of the National Association of Retired and Veteran Railroad Employees, even claims to know the amount: $50 million. But when I asked her where that figure came from, she said, "It's just something I hear from a good number of railroad retirees in our different units across the country, men who were working at the time.'

The rumors persist despite denials from the government, the unions, and the carriers. Says Frank N. Wilner, a spokesman for the American Association of Railroads, "It's like the tale of Proctor and Gamble contributing to the devil.'

In part, the rumors of government raiding the coffers have arisen because of mind-numbing accounting methods that transfer money between the pension funds and the Social Security account. This system, called "financial interchange,' was meant to make sure that neither system subsidized the other. In the early 1950s, when there were still more workers than retirees in the railroad industry, the railroad retirement system paid substantial sums to Social Security. Since 1957, however, Social Security has been the locomotive hauling the railroad retirement system.

In addition, these rumors arise because the railroad retirement system, like all federal pension programs, purchases government bonds whenever it has cash left over after meeting current expenses. These bonds, in turn, are used to help finance government's day-to-day operations --but are repaid, with interest. And, of course, the rumors also persist because they're what people want to believe. Few retirees want to think of themselves as first-class passengers on a welfare locomotive. It's easier to strike the pose of victim instead.

Japan si, Amtrak no

The explosion in railroad taxes now threatens the very survival of the railroad industry--and, as a consequence, railroad retirement itself. Combined payroll taxes have risen from an original 6 percent to 33.3 percent today. And President Reagan, that avowed opponent of tax hikes, has sought to push them even higher, to 36.3 percent in the next two years. Since 1937, the taxes borne by the railroads have jumped from a maximum of $99 per employee to almost $8,000 a year for a typical union worker today.

These tax hikes beget a crazy cycle. As taxes rise, employment drops, so taxes rise again. Since 1979, railroad employment has fallen 44 percent. Sure, a lot of that stems from the general decline of American manufacturing, but the retirement program has increased the blow. "The railroads keep laying off workers just so they can pay higher payroll taxes,' complains John McCown, a spokesman for the Brotherhood of Locomotive Engineers. It's gotten so bad, according to Norman Soloman, chief actuary for the Railroad Retirement Board, that workers entering the railroad industry today stand just a 40 percent chance of holding their jobs long enough to qualify for any pension.

Yet the carriers have little choice but to lay off workers. The Bangor and Aroostook Railroad, for example, pays twice as much in railroad retirement taxes as it does for diesel fuel, and three times as much as it earns in after-tax profits, according to Executive Vice President David Hughes. "There's only one thing we can do when payroll taxes go up,' says Hughes, "and that is layoff people.'

With these pressures, no wonder Amtrak is always in danger of going under. A full 23 percent of its personnel costs goes towards retirement, compared to 3.1 percent for the average pension plan, according to the Commerce Department. One quarter of its federal subsidy goes towards retirees. With this burden, the U.S. stands no chance of developing the state-of-the-art railroads enjoyed in France and Japan.

What makes this situation especially galling to Amtrak officials is that only one-tenth of these taxes go to former Amtrak employees. In existence only since 1971, Amtrak has relatively few retirees. Its huge pension taxes go to support retirees from other railroads who never even worked for Amtrak. Were it allowed to develop its own private pension plan, Amtrak could provide all the benefits the railroad retirement system currently pays to its employees, pre-fund all future benefits, and still save at least $20 million a year--even if its workers made no contributions to such a plan. Yet if Amtrak is allowed to opt out of railroad retirement, the system will go broke that much sooner.

Felix Rohatyn, beware

How can we ever get out from under this mess? No one in the industry seems to have any idea, except to ask Congress to appoint another special commission, like the one they established in 1970 to develop a permanent solution. Sadly, the rail unions, whose workers stand to lose the most if the pension system collapses, concentrate their energies on preserving benefits for current beneficiaries, with little regard for the retirement needs of their younger workers. "Politically, it's unthinkable that anyone would get up a union convention and say, "Let's get ourselves out from underneath this plan,'' says one union official.

These days politicians in both parties share a fantasy that somehow a cooperative triangle of labor, management, and government can sit down at a table and, with Kennedy-School-like efficiency, work out problems like railroad retirement. In fact, the railroad retirement system has been run by just such a committee from the beginning. The railroad retirement board's three members come from industry, labor, and government. Industrial policy mavens like Felix Rohatyn should pay attention to what's been wrought.

The conservative solution, peddled by Reagan's Office of Management and Budget, is a long-term plan for privatizing the railroad retirement system. But any attempt to put the system on a sound actuarial basis would be prohibitively expensive, at least in the short term, because the system is already obligated to pay $44 billion in future benefits even if the railroad industry never hires another worker. The American Association of Railroads estimates that a financially sound private plan would require payroll taxes nearing 50 percent. And even if a private plan could be set up under law, the federal government must insure it against collapse.

The answer is clear: There is no way these debts will go away, unless Congress cuts benefits for current and future retirees.

In confronting the looming bankruptcy of the railroad retirement system, it is important that we learn from our mistakes. Railroad retirement has its own special problems, but it is failing for the reasons all our social insurance programs are failing: we've promised more than we can deliver.

Medicare, for example, is projected to be insolvent by the year 2002, according to system actuaries, but Congress continues to add new benefits. Because we're a graying country, the Social Security system may eventually require payroll taxes as high as 40 percent, which would devastate the American economy. We cannot simply assume that the next generation can pay for the promises we make. Nor can we meet the challenges of an aging society by allowing special interests to run the government and make commitments we cannot afford. Unless we radically change direction, the railroad retirement system signals trouble down the line.