Choosing Among Bad Options to Fix Our Pension Mess

Good Choice Bad ChoiceSo now we know that next year the State of Illinois will have to shell out 24% of its state budget just to pay pensions, and we strongly suspect that we’re having smoke blown at us if we believe the underfunding of the state’s 5 pension plans is “only” $111 billion.

What’s to do about it? Since states cannot file for bankruptcy, perhaps all we have left is an old saying attributed to “Reefs and Shoals” a handbook for cadets at the U.S. Naval Academy dating from the 1920’s that goes: “When in danger or in doubt, run in circles, scream and shout.”

But this is a serious issue, and deserves a serious response. For years, Illinois’ politicians have in effect borrowed money from the pension plans by not making required contributions or by overstating the expected rate of return on the portfolio so as to lower the amount of such contributions as have been made. While enactment of the Tier II pension system for new employees is supposed to stop the continued increase in pension accruals, the question remains: How do we pay off the $111 billion or $300 billion or whatever amount by which the funds are short?

In a 2010 article from the Chicago Tribune, economists Robert Novy-Marx and Joshua Rauh listed what few options the state has:

  • Taxpayers pay for it all in higher taxes and reduced public services. But it is hard to see us finding an extra $200 billion anytime soon. State and local government tax revenues in Illinois are around $55 billion annually, and budget shortfalls are colossal.
  • Continue to borrow to fund pensions. This tactic restructures the debt to employees so that it becomes debt to investors. Unfortunately, future generations of taxpayers would shoulder the burden. Illinois has already made $13 billion of pension bond issues, which are expensive as they enjoy no tax subsidies. The silver lining is that to keep borrowing, Illinois will soon need to credibly show capital markets a reform of its entire budgetary process.
  • Increase retirement ages for existing employees to 67 and eliminate openhanded early retirement deals. The Illinois Constitution states that public employee pension benefits may not be diminished or impaired. But if we are putting all options on the table, this one also has to be there, even if it involves changing the constitution.
  • We could do nothing and end up like Greece. If so, Illinois will eventually default on some of its $26 billion of outstanding general obligation and pension bond debt. The depletion of the state’s pension funds, which is quite likely within the next 10 years, will provide a catalyst. Illinois will then end up at the federal government’s doorstep, hat in hand. This should be avoided at all costs. Markets already are charging more for insurance on Illinois bonds than for bonds issued by Spain, Portugal or California.

Not an inviting set of options, is it? I’ve written before on the issue of pension insolvency, pointing out that while pension benefits are guaranteed, there is no such requirement that the State actually fund the plans. So one of these days somebody’s going to present a check on a pension account that’s overdrawn.

As to increasing taxes, we’ve been down that road, as I mentioned here:

From 2011 through 2013, taxes collected by the state increased almost 25%, and the funding ratio of our pension plans declined by 4%.
To you who are banging the drum for a tax increase I say: “You’ve had your chance. You got your tax increase and you pissed it away. What makes you think you deserve more?”

One thing that I would like to see is a carving off of the underfunded portion of our pension obligation from the budgeting process. By creating a separate revenue stream to retire our pension debt, all the players in this drama would be faced straight on with the enormity of our predicament. What would be the source of that revenue stream would be up for negotiation, but to continue to lump our past pension obligations in with ongoing state services and obligations adequately serves neither. Also, by giving the people a clear view of the size of the problem, they may be more motivated to accept a constitutional amendment removing the pension guarantee.

The only way we’re going to climb out of this mess is to expand Illinois’ economy and put more people on the tax rolls. That’s only going to come through systemic change, from our tax system to the way we fund education, from enacting real reforms to our workers’ comp system to gaining a release of the stranglehold that public sector unions have over the way business is conducted in this State.

It’s not going to happen overnight, but we need to start.

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