The Betrayal of Public Workers
State Pension Funds Are Not Collapsing
Not surprisingly, state and local government pension funds absorbed heavy losses in the 2008–09 Wall Street crisis, because roughly 60 percent of these pension fund assets were invested in corporate stocks. Between mid-2007 and mid-2009, the total value of these pension funds fell by nearly $900 billion.
This collapse in the pension funds’ asset values has increased their unfunded liabilities—that is, the total amount of benefit payments owed over the next thirty years relative to the ability of the pension funds’ portfolio to cover them. By how much? In reality, estimating the total level of unfunded liabilities entails considerable guesswork. One simply cannot know with certainty how many people will be receiving benefits over the next thirty years, nor—more to the point—how much money the pension funds’ investments will be earning over this long time span. The severe instability of financial markets in the recent past further clouds the picture.
Thus, these estimates vary by huge amounts, depending on the presumed rate of return for the funds. The irony is that right-wing doomsayers in this debate, such as Grover Norquist, operate with an assumption that the fund managers will be able to earn returns only equal to the interest rates on riskless US Treasury securities. Under this assumption, the level of unfunded liabilities balloons to the widely reported figure of $3 trillion. To reach this conclusion, the doomsayers are effectively arguing that the collective performance of all the Wall Street fund managers—those paragons of free-market wizardry—will be so anemic over the next thirty years that the pension funds may as well just fire them and permanently park all their money in risk-free government bonds. It follows that the profits of private corporations over the next thirty years will also be either anemic or extremely unstable.
But it isn’t necessary to delve seriously into this debate in order to assess the long-term viability of the public pension funds. A more basic consideration is that before the recession, states and municipalities consistently maintained outstanding records of managing their funds. In the 1990s the funds steadily accumulated reserves, such that by 2000, on average, they were carrying no unfunded liabilities at all. Even after the losses to the funds following the previous Wall Street crash of 2001, the unfunded share of total pension obligations was no more than around 10 percent. By comparison, the Government Accountability Office holds that to be fiscally sound, the unfunded share can be as high as 20 percent of the pension funds’ total long-term obligations.
A few states are facing more serious problems, including New Jersey, Illinois and California. New Jersey is in the worst shape. But this is not because the state has been handing out profligate pensions to its retired employees. The average state pension in New Jersey pays out $39,500 per year. The problem is that over the past decade, the state has regularly paid into the system less than the amount agreed upon by the legislature and governor and stipulated in the annual budgets. For 2010 the state skipped its scheduled $3.1 billion payment altogether. However, even taking New Jersey’s worst-case scenario, the state could still eliminate its unfunded pension fund liabilities—that is, begin running a 100 percent fully funded pension fund—if it increased the current allocation by about 4 percent of the total budget, leaving 96 percent of the state budget allocation unchanged.
In dollar terms, this worst-case scenario for New Jersey would require the state to come up with roughly $4 billion per year to cover its pension commitments in an overall budget in the range of $92 billion. Extracting this amount of money from other programs in the budget would certainly cause pain, especially when New Jersey, like all other states, faces tight finances. But compare this worst-case scenario with the bankruptcy agenda being discussed throughout the country.
To begin with, seriously discussing a bankruptcy agenda will undermine the confidence of private investors in all state and municipal bonds—confidence that has been earned by state and municipal governments. When the markets begin to fear that states and municipalities are contemplating bankruptcy, this will drive up the interest rates that governments will have to pay to finance school buildings, infrastructure improvements and investments in the green economy.
Then, of course, there is the impact on the pensioners and their families. For the states and municipalities to walk away from their pension fund commitments would leave millions of public sector retirees facing major cuts in their living standards and their sense of security. Something few Americans understand is that roughly one-third of the 19 million state and local employees—i.e., those in fifteen states, including California, Texas and Massachusetts—are not eligible for Social Security and will depend exclusively on their pensions and personal savings in retirement. In addition, public sector pensions are not safeguarded by the federal Pension Benefit Guaranty Corporation. Unlike Wall Street banks, state pensioners will receive no bailout checks if the states choose to abrogate their pension fund agreements.
Getting Serious About Reforming State Finances
Of course, there are significant ways the public pension systems, as well as state and local finances more generally, can be improved. The simplest solution, frequently cited, involves “pension spiking”—that is, practices such as allowing workers to add hundreds of hours of overtime at the end of their careers to balloon their final year’s pay and their pensions. This has produced serious additional costs to pension obligations in some states and municipalities, but it is still by no means a major factor in explaining states’ current fiscal problems.
But states and municipalities also have to follow through on the steps they have taken to raise taxes on the wealthy households that are most able to pay. They should also broaden their sources of tax revenue by taxing services such as payments to lawyers, as well as by taxing items purchased over the Internet. And they have to stop giving out large tax breaks to corporations as inducements to locate in their state or municipality instead of neighboring locations. This kind of race to the bottom generates no net benefit to states and municipalities.
Finally, state and local governments are in the same boat as the federal government and private businesses in facing persistently rising healthcare costs. As was frequently noted during the healthcare debates over the past two years, the United States spends about twice as much per person on healthcare as other highly developed countries do, even though these other countries have universal coverage, longer life expectancies and generally healthier populations. These costs weigh heavily on the budgets of state and local governments, which finance a large share of Medicaid and health benefits for state employees. The problem is that we spend far more than other countries on medications, expensive procedures and especially insurance and administration. We also devote less attention to prevention. It remains to be seen how much the Obama healthcare reform law—the 2010 Patient Protection and Affordable Care Act—will remedy this situation. It is certainly the case that more must be done, especially in establishing effective controls on the drug and insurance industries.
These are some of the long-run measures that must be taken to bolster the financing of education, healthcare, public safety and other vital social services, as well as to support investments in infrastructure and the green economy. If states declare bankruptcy they will break their obligations to employees, vendors, pensioners and even bondholders, which will undermine the basic foundations of our economy. As we emerge, if only tentatively, from the wreckage of the Great Recession, this is precisely the moment we need to strengthen, not weaken, the standards of fairness governing our society.