While the US Federal Government is under constant fire for its growing national debt, many state and local governments are facing their own fiscal crises: since 2008, dozens of US municipalities have filed for bankruptcy. The reasons behind this have been numerous, but for many municipalities a ballooning gap in public sector pension funding has been a major contributor to their fiscal black holes.
Across the US, regional authorities are in the throes of a public pension funding crisis. State public pension plans, according to Wilshire Consulting, held only 73 percent of the required assets to meet their obligations in 2015. Meanwhile, the Hoover Institution – a US public policy think tank – reported that, overall, US public pensions have a funding gap of $3.4trn.
There is, it would seem, a burgeoning crisis at hand – so much so that in 2014 The Economist asked if the US’ regional government pension liabilities had created “America’s Greece”. Stephen D Eide, Senior Fellow at the Manhattan Institute, told World Finance that, without reform, “more cities will be driven into insolvency and have to file for bankruptcy, all state and local governments will see more and more revenue going to pensions – the costs of the past – and less and less going to services for current generations of taxpayers”.
Public sector problems
In theory, each public sector worker’s retirement plan should more or less pay for itself; contributions paid during years of service are added into a collective pot that is invested, so the proceeds fund each worker’s retirement payout later down line. Yet the promises made on pensions are now hugely out of kilter with many state and local government plans’ actual ability to pay.
Funding gap of US public pensions
It is often argued this gap stems from the fallout of the 2008 financial crisis. According to a paper published in June 2016 by the National Association of State Retirement Administrators (NASRA): “The global stock market crash sharply reduced state and local pension fund asset values, from $3.2trn at the end of 2007 to $2.1trn in March 2009.” This low return, it is said, is responsible for the liabilities gap.
In 2015, The Wall Street Journal noted: “Returns for US public pensions are expected to drop to the lowest levels ever recorded.” This means the cost of retirement payments to public sector workers is increasingly difficult to meet.
Yet while market conditions have certainly slowed asset returns, for many states, unfunded liabilities predate the post-2008 asset crunch. According to The Trillion Dollar Gap, a 2010 study by the Pew Trust: “In 2000, slightly more than half the states had fully funded pension systems. By 2006, that number had shrunk to six states. By 2008, only four – Florida, New York, Washington and Wisconsin – could make that claim.” Evidently, the problem predates any post-2008 fallout.
The cost of retirement payments to public sector workers is increasingly difficult to meet
Even when asset returns have recovered, the gap still gapes. As the Pew Trust noted in its 2016 study The State Pensions Funding Gap: Challenges Persist, public pension plans “have [since] benefited from strong investment returns.” Yet, the report continued: “The gap between the pension benefits that state governments have promised workers and the funding to pay for them remains significant.” The decline of asset returns has certainly compounded the funding crisis – but it didn’t cause it.
For the true cause, many point towards the generous pension systems that are offered to state and local government employees. According to a study by the American Enterprise Institute, former public sector workers draw much larger pensions than those who worked in the private sector. The paper, titled Not So Modest: Pension Benefits for Full-Career State Government Employees, noted: “Indeed, the average full-career government worker in eight states retires as a ‘pension millionaire’, with 23 states paying $750,000 or more in lifetime retirement benefits.” Pension compensation varies from state to state, but as the study also noted: “In the average state, an average full-career state government employee has a combined pension and social security income higher than 72 percent of full-time employees working in that state.”
Footing the bill
It could be argued the large pension plans for public sector workers are deserved: they have put a lifetime into working for the public good of their state or regional government, and should be rewarded accordingly. Yet the problem is that, if the state’s public pension plan cannot afford to provide the retirement promises it has made, that money must come from somewhere else: taxpayers.
Take Nevada, for instance. It is one of the states with the worst public sector pensions black holes. According to a study by the Nevada Police Research Institute, Reforming Nevada’s Public Employees Pension Plan, full-time, lifelong public sector worker pensions “are 55 percent more generous than those for a typical private-sector worker with social security and a 401(k)”. As a result, 12 percent of all Nevada’s state and local tax revenue in 2013 went to filling the gap in its public pension funds.
Chicago, which also has one of the largest funding holes for its pension system, offers a microcosm example of this. In the Chicago Public Schools (CPS) system in particular, pension liabilities – or rather, the ability of state pension plans to fund these – have grown massively. This is outlined in Chicago Crowd-Out: How Rising Pension Costs Harm Current Teachers – and Students, a report by the Manhattan Institute. It noted: “Since 2001, the CPS’ actual pension contribution – for benefits that its teachers, retired or still working, have already earned – has grown more than sevenfold, while the CPS’ revenue has grown by only about 11 percent.” To fund this widening gap, fewer and fewer resources – including funds for textbooks and new facilities – have been dedicated to schools.
As a result, 12 percent of all Nevada’s state and local tax revenue in 2013 went to filling the gap in its public pension funds
In the worst-case scenarios, pension obligations have pushed entire towns into bankruptcy. Stockton, California has a population of just 300,000. In 2012, it filed for bankruptcy with $700m worth of debt. Its biggest debt obligation? The California Public Employees Retirement System. Detroit’s now-infamous 2013 bankruptcy is also often blamed – among a myriad of other reasons – on its growing pensions obligations.
While the 2008 recession and resulting asset returns did not cause the US’ pensions crisis, together they have kicked state and local governments into action. Governments now recognise they need to act fast if they hope to stave off this growing catastrophe.
Broken pension promises
Most state and local governments have enacted some sort of public pension sector reform in recent years. NASRA, in its aforementioned paper, detailed these changes from 2009 onwards. Over 40 different public sector pension plans in a total of 36 states increased member contribution – some temporarily, most indefinitely or permanently. The majority of these contribution increases have been for new employees only, although a small number of plans have applied them to existing workers.
Benefits to which pension receivers are entitled have also been adjusted downwards in a total of 39 states. Eight of these states reduced cost of living adjustments for new workers, while eight did so for current and new employees, and 14 states did so for retirees. Nine states also raised their vesting period for new hires from five to 10 years, while 29 states raised retirement eligibility either through increased years of service or the age at which an employee can begin to draw their pension.
It isn’t possible to allow growing pensions obligations to be paid for out of resources intended for use on future generations or other groups
While many of these reforms have made slight savings – even in the face of tough opposition from parties with vested interests – the funding gap persists, particularly where it is not possible to change pension plan terms for existing employees. Substantial reform is hard to achieve. Part of the problem is not knowing where reforms should, or even can, be made first.
For instance, in the case of the CPS pension system, the brunt of savings have been felt by the newest hires in the school system, who have received vastly reduced pension plans compared with those of pre-existing employees. Those already employed and entitled to certain public pension benefits, or already retired, cannot be touched as per a ruling by the Illinois Supreme Court.
There is a reasonable case to be made that it would be unfair to now trim the pension payouts that had previously been promised to retirees or current employees: through no fault of their own, these people have been offered pension plans that can no longer be serviced. Changing the terms of these pensions now would be likely to alter many people’s retirement plans.
Yet not reneging upon these now-unfundable promises hurts other, equally not at fault groups, such as CPS students who no longer receive the appropriate resources. Quite often, the gap in funding is so large that it isn’t possible – let alone politically feasible – to allow growing pensions obligations to be paid for out of resources intended for use on future generations or other groups.
US state and local governments will have to confront this seemingly unsolvable issue: pay what has been promised, even if it can be agreed that those promises should never have been made. The only alternative is to force taxpayers and future hires to foot the bill.