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Zywicki in Barron's: States Could Default Over Ballooning Pension Payments

A March Barron's article points out that despite populist anger over executive compensation, the larger threat is that of pensions for 23 million active and retired state and local public employees, something that may come to haunt many jurisdictions in the not-so-distant future.

Professor Todd Zywicki says in the article, "In many ways, some of our states are like General Motors before its bankruptcy, suffering from falling revenue, borrowing money to cover operating expenses and operating under crushing legacy health and pension liabilities. It's entirely possible, given the gigantic size of the pension liabilities, that some states might do what was once the unthinkable at GM and default."

Approximately 80% of public employees are the beneficiaries of defined-benefit plans that are protected against inflation, and most can count on pensions equal to 75% to 90% of their pay in their highest-earning years, says the article. Eight states currently lack funding for more than one-third of their pension liabilities, and 13 others are less than 80% funded. Governments could close the gap through increased taxes, but more likely are cuts in essential services in order to cover pension liabilities.

The $2 Trillion Hole, Barron's, March 15, 2010. By Jonathan R. Laing.

Excerpt:

"The current state and local pension crisis has many fathers. State and local governments have been under-funding their pension systems for a decade or more, under the misapprehension that the stock-market boom of the 1990s would continue and bail out any shortfalls. The underfunding has continued with a vengeance over the past two years as budgets were slashed to eliminate deficits.

"For example, last year New Jersey, under Gov. Jon Corzine --a financially savvy former Goldman Sachs chief -- contributed only $105 million, instead of an actuarially determined $2.3 billion. In all, states and localities kicked in $72 billion in fiscal 2008, far short of adequate funding levels of $108 billion, according to the recent Pew study.

"Such behavior is only encouraged by the fact that state and local governments are allowed as much as 30 years to close funding gaps. So it's easy for politicians to kick the can forward, avoiding the pain of boosting taxes and making hard spending decisions. The 30-year amortization periods have an evergreen nature, being renewed and invoked almost every year as the compounding of pension obligations works relentlessly against units of government.

"Then, too, pension funds are being hit by baby-boomer retirements. A report from the National Association of State Retirement Administrators underlines this impact: It found that in 2008, for every state retiree collecting benefits, only 2.02 current workers were contributing to pension systems, compared with 2.45 in 2001.

"Besides the politicians, the primary culprits are the public-employee unions, which have used their growing power to dramatically enhance pension benefits. They curry favor with sympathetic politicians, lavishing them with large donations and manning campaign phone banks. They also engage in full-court-press lobbying at all levels of state and local government.

"One would think legislators or managers in state, county and local governments would protect the taxpayer by bargaining hard. But they clearly don't, because of inherent conflicts of interest.

"Nearly all public employers, regardless of their position, benefit from the very same pension programs, either directly or indirectly. Legislators in the main receive the same pension benefits that they lavish on other public employees. And administrators, though subject to independently negotiated contracts, use enriched union pension plans as a valuable bargaining wedge. So there's little incentive to fight the unions with much vigor."

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The current state and local pension crisis has many fathers. State and local governments have been under-funding their pension systems for a decade or more, under the misapprehension that the stock-market boom of the 1990s would continue and bail out any shortfalls. The underfunding has continued with a vengeance over the past two years as budgets were slashed to eliminate deficits.

For example, last year New Jersey, under Gov. Jon Corzine --a financially savvy former Goldman Sachs chief -- contributed only $105 million, instead of an actuarially determined $2.3 billion. In all, states and localities kicked in $72 billion in fiscal 2008, far short of adequate funding levels of $108 billion, according to the recent Pew study.

Such behavior is only encouraged by the fact that state and local governments are allowed as much as 30 years to close funding gaps. So it's easy for politicians to kick the can forward, avoiding the pain of boosting taxes and making hard spending decisions. The 30-year amortization periods have an evergreen nature, being renewed and invoked almost every year as the compounding of pension obligations works relentlessly against units of government.

Then, too, pension funds are being hit by baby-boomer retirements. A report from the National Association of State Retirement Administrators underlines this impact: It found that in 2008, for every state retiree collecting benefits, only 2.02 current workers were contributing to pension systems, compared with 2.45 in 2001.

Besides the politicians, the primary culprits are the public-employee unions, which have used their growing power to dramatically enhance pension benefits. They curry favor with sympathetic politicians, lavishing them with large donations and manning campaign phone banks. They also engage in full-court-press lobbying at all levels of state and local government.

One would think legislators or managers in state, county and local governments would protect the taxpayer by bargaining hard. But they clearly don't, because of inherent conflicts of interest.

Nearly all public employers, regardless of their position, benefit from the very same pension programs, either directly or indirectly. Legislators in the main receive the same pension benefits that they lavish on other public employees. And administrators, though subject to independently negotiated contracts, use enriched union pension plans as a valuable bargaining wedge. So there's little incentive to fight the unions with much vigor.