Human nature being what it is, it’s no surprise to me that local, state, and federal entities across our country continue to largely ignore the looming crisis of our public sector pensions. More often than not, politicians delay addressing this pressing issue to avoid potentially losing the support of voters. Afterall, it’s always easier to kick the can down the road.
Let’s begin with a brief background on what a public sector pension is and how it operates. For this post, we will ignore private sector pensions which are similar, but are guaranteed by the Pension Benefit Guarantee Corporation, and whose shortfalls do not theoretically fall on the taxpayer. Pensions are offered to public sector employees as part of a package of retirement benefits to be received in the future. The employing government agency sets aside (or should set aside) ample funds to cover these future obligations.
However, as is the case for many things that can be put off, funding frequently is, or is not made in large enough amounts. The liability is an actuarially calculated value based upon the total liability less total funding to date. Total funding is easy to pin down, the liability is more nebulous and takes into account factors such as life expectancies, salaries, compounded growth on funded assets, etc. A recent PEW study found a fiscal 2009 shortfall of $217.2 billion in unfunded municipal retiree liabilities including pensions, health care, and other across 61 of the most populous cities in the U.S. Bear in mind this is for local municipalities only and does not include State and Federal obligation.
On top of these municipal liabilities, the next layer of costs to be forced upon future taxpayers includes State retirement obligations. Moody’s recently released a report indicating that the median net fiscal 2011 unfunded pension liability for all states is 45% of those states’ annual revenues. In equivalent terms, this is equal to an individual carrying a debt burden of 45% of their annual salary with no offsetting asset. This is the hidden debt burden carried by states across the union solely for unfunded pension liabilities. The final layer of costs (which is admittedly outside the scope of this post due to differing mechanics and the widely implausible scenario of Federal Government bankruptcy) includes Federal unfunded retirement obligations in the tens of trillions of dollars.
It doesn’t take a genius to see how this plays out for taxpayers and pensioners. We will actually have front row seats as the Detroit bankruptcy drama unfolds at the municipal level. Absent any current action by governments across the country, and pending the outcome of Detroit’s bankruptcy, two main options will present themselves over time:
1) Pensioners will see a cut to their promised benefits and/or
2) Taxpayers will see future tax increases.
The effects of delaying meaningful reforms will increase the impact of both of these options in the future. Actions that, though difficult they may seem, can be implemented today include any combination of the following: increasing the retirement age, increasing individual contributions, phasing in future decreases in benefits, limiting annual benefit increases to the cost of inflation, and privatizing accounts.
As we’ve seen historically, however, it is nigh impossible for politicians to make difficult decisions such as these at the expense of decreased support at the polls by the affected groups. Delays only worsen the future impact, however, and put an unfair and unethical burden on future taxpayers. In fact, to avoid these future tax increases, citizens may simply emigrate from more egregiously underfunded municipalities. The time to act on these issues is at present, not after the next election. Look no farther than Detroit as an example of this cautionary tale.
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