Discussion Paper

Paychecks or Promises? Lessons from the Death Spiral of Detroit

Abstract: Pay-with-promises compensation plans accumulate liability for future employee benefits, such as retiree health insurance. A simple economic model demonstrates that such plans can exacerbate fiscal crises faced by cities that experience external economic shocks, such as the departure of a major employer. City leaders often raise taxes and/or reduce public services to pay off legacy employee debts, and such steps encourage residents to move out, reducing the tax base and raising fiscal stress. Pay-as-you-go compensation plans are more prudent; they settle liabilities to employees paycheck by paycheck.

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Economic Policy Paper

Publication Date: 2014-09-25

Number: 14-4