COMMENTARY Municipal, state workers should take their pension money and run, fast

May 2, 2012

Public employees should take their pension money now and run to avoid risk of getting reduced benefits - or nothing - in the future. It's the best deal for them and for taxpayers. A growing chorus of credible voices including the Government Accountability Office, a Federal Reserve bank and now the Harvard Kennedy School Mossavar-Rahmani Center for Business and Government confirm state and local government finances are "spiraling out of control" and even draconian reforms only make it "more likely" that future benefits will paid in full.

The just-released Harvard study bluntly states: "Across the United States, state and local government-sponsored pension plans are in trouble. They are dangerously underfunded to the extent that their assets are unable to meet future liabilities without either outsize investment returns or huge cash infusions."

Guess what? Those outsize investment returns are not going to happen, and there is no cash for huge infusions.

GAO, the Fed and this latest study in fact confirm state and municipal pension funds are actually increasing risk in desperate efforts to make up for the sucker punch Wall Street hit them - and the rest of the world - with in 2008. Increased risk means bigger losses next time. The one thing we can count on is there will be a next time.

As for "cash infusions;" whose cash? Taxpayers are tapped out and angry. And unfunded pensions are not the only catastrophe state and local politicians have inflicted on us.

Eventually, all public pensioners are going to have to get in a long line of people and projects -- ranging from bondholders and Medicaid recipients to current workers and bridges -- clamoring for more from the dwindling number of private sector workers who pay for everybody else. Adding it all up, about $18 trillion is coming due.

Somebody has to lose. The Harvard study authors point out that "estimates of the total size of the public pension problem in the U.S. have ranged from $730 billion in unfunded liabilities to $4.4 trillion," depending on whether you accept official government assumptions or those of economists who "believe that the true size of the total unfunded liability lies closer to the larger estimates than it does to the smaller."

They point out that $4.4 trillion equals 33 percent of 2011 gross domestic product and is three quarters the size of Social Security obligations even though state and municipal workers are only one twentieth of the population.

"The sooner plan sponsors (states and, in many cases, local governments) implement meaningful reforms, the less likely the problem will continue to spin out of control. However, many states and municipalities face an uphill climb in implementing reforms, with legal and political obstacles impeding progress. In the case of pension reform, time is money, and any delay in implementing needed changes will likely cost taxpayers __ and public pension beneficiaries - significant resources."

The authors propose specific reforms "potentially reducing the cost to taxpayers by as much as 85 percent."

And they stress, "Most notably, sound reform makes it all the more likely that public pension plans will still exist and be in a position to pay out benefits well into the future."  More likely? Pensions are supposed to be guaranteed in perpetuity.

Adding realistic estimates of local pension plan shortfalls, the authors conclude an additional tax increase of at least 12 percent a year every year for 30 years will be required to fund pensions but provide no public services of any kind.

Absent major additional reforms, the authors state (emphasis theirs): "In the face of such overbearing financial burdens, there are no easy answers. To fully fund both state and local public pension plans ... every household in the United States would have to be assessed an additional tax of $1,398 a year for 30 years. This tax would have to be levied on top of any additional tax revenue generated through economic growth ....

"This means that regardless of the inclinations of state elected officials, it will be extremely challenging to institute tax increases to properly fund state pension plans (and nearly as difficult to cut other state expenditures to accomplish the same goal). This scenario points to a looming showdown between taxpayers, elected state officials and many public sector unions."

That showdown could get ugly because, "public employees at the state and local level have seen an increase in their compensation that outpaces the increase in private sector employee compensation since 1998."

The report summarizes many of the abuses that increase the drain on public pensions, but fail to note the cost of such abuses now are not included in even the worst funding shortfall estimates because nobody knows how massive they are.

One thing the authors do make clear: "With greater burdens of cost being shifted to smaller populations of public employees and taxpayers, the already growing costs of public pension plans can become unsustainable."

Even though at least 43 states have passed various pension reforms that could prevent costs from continuing to rise decades from now, they have little impact on the existing unfunded liabilities.

Even those limited changes have run into stiff opposition, "... the road to substantive pension reform is a difficult one, fraught with legal, political and financial obstacles."

As a result, "Nearly all states are facing a major financial challenge when it comes to funding their pension promises."

As for what happens when the money runs out, the authors cite recent examples and conclude, "Clearly, once-safe assumptions regarding the permanence and financial stability of governments are worth reconsidering in light of such occurrences. Arguably, no group should be more concerned about this reality than the beneficiaries of unsustainable public pension plans."

The report summarizes the most effective state reform efforts to date, including Utah, which was in better shape and imposed the most radical reforms. But even there pensions are only "in less danger of becoming insolvent, and its public workers' retirement benefits are more secure. Granted, there still exists an element of intergenerational risk ...."

If the most radical pension reforms in the country still cannot guarantee benefits, what is going to happen in states and municipalities that fail to reform?

The authors conclude, "The financial outlook for many public pension plans is bleak, but solutions do exist." However, time is running out. "Clearly, every day that reform is delayed, liabilities mount and the journey toward meaningful change becomes that much harder."

And the big problem is, "...public pension reforms are often most strongly opposed by those who stand to benefit most from their implementation: public sector workers."

Public sector workers should see the inexorable catastrophe coming and demand their money now before politicians and union leaders can skim any more of it.

For every dollar public workers contributed to their pensions between 2007 and 2010, fund managers lost $4.33. Their money is gone forever. If they expect taxpayers to make up the difference they ultimately either will trigger fiscal revolt or plunge their states and cities into permanent economic decline.

Right now the best thing they can do is demand their money back, plus government contributions, at the official discount rate, with future government contributions paid in every check.

That puts the workers in control. They can invest any way they choose.

But the most important fact is: If politicians try to short them again, they will know immediately instead of finding out the hard way when they are old and it's too late.

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