Your state may not be as fiscally solvent as politicians have led you to believe, according to a new report.
The Competitive Enterprise Institute (CEI) released a report in July detailing the multi-trillion dollar gap in state pension funding that could soon render many states, including Illinois and California, insolvent. The report paints a dire picture of a relatively obscure political issue that has been decades in the making and could drive entire states into bankruptcy.
"The rules that apply to government accounting of public pension plans enable governments to use rosy assumptions about investment returns to make pension assets look sufficient to cover pension liabilities," the report says. "Many government reports show pension plans being well-funded, even though the accounting standards used by private companies in the United States and most governments throughout the world would show they are not."
Government entities have been able to mask enormous pension debt for decades thanks to lax accounting standards, most notably concerning assumed rates of return. While companies are forced by law to tie their growth to corporate bond rates, governments are able to choose investment rates that have little basis in reality, according to the report. High return rates allow the government to underfund pensions by making the debt appear smaller than it actually is.
In the years leading up to the 2008 market crash, many governments assumed annual growth as high as 8 percent—far higher than what private sector pensions are allowed to use, according to the report.
CEI Senior Fellow Aloysius Hogan said that the group wants to use the state-by-state analysis to better inform residents, who may operate under the impression that their state government is paying all of its bills, while failing to properly save money for its retirees. He pointed to Illinois, which is more than $100 billion short of meeting its retirement obligations to government workers, despite the fact that the state has a balanced budget law that requires it not to enter new fiscal years carrying debt.
"Pensions are the least sexy thing out there. People worry about the current year and immediate problems," Hogan said. "Rather than focus on the here and now, it is important to plan ahead and save because what you’re going to end up doing is sticking taxpayers down the road."
Detroit demonstrated what happens if state and local governments fail to properly fund their pension systems when it entered into the largest municipal bankruptcy in history in 2013. The state had a nearly $20 billion budget gap when it became insolvent.
Hogan said that the CEI study, which averages data from six sets of pension data, is intended to prevent the shock that comes with unseen debt. Many state constitutions guarantee pension payments and states, unlike cities, are not permitted to enter into bankruptcy. The retirement money will have to come from either program cuts or higher taxes, both of which can hinder business development in an area.
"It is going to be the taxpayer who has to pony up. Businesses are going to be deterred from going into business climates where they’re paying more and getting worse public service in return," Hogan said. "You can expect businesses to head to the more fiscally prudent state."
Taxpayers are not the only ones hurt by the enterprise, according to Hogan. Unionized public sector workers are also vulnerable, especially in states that do not have constitutional guarantees. Detroit retirees were forced to take a "hair cut" on their retirement packages in order to help the city recover from bankruptcy. Hogan said pandering union leaders deceive workers when they resist reforms that can keep a system solvent.
"Many of these workers are not eligible for Social Security. We’re talking about people’s entire livelihood in their retirement years," Hogan said. "In the end it hurts retirees when government unions issue demands that exceed what can realistically be paid back."