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In the Red: US State Pension Obligations Tower Over Assets

By: Nick Zaiac - @NickZaiac - Sep 8, 2014, 4:07 pm

EspañolThe states are in trouble, and it’s much worse than you think. At least that is the take away from a recent report from Truth in Accounting, a state budget transparency watchdog organization.

But how can that happen when most states are required by law to have balanced budgets? Problems arise because balanced budget requirements are easy do dodge, often only applying to general fund obligations and almost never factoring in promised retirement compensation for current employees.

How bad is the issue? Only nine states have assets that cover their current obligations, while 41 others do not have enough current assets to pay their bills in the future when pension obligations come due.

This raises a pair of important and related issues. The first is government transparency. When states say they have balanced budgets, voters believe them. Most voters are not wonkish types who will dig through reports, and few could even define an “unfunded liability.” By claiming to have balanced budgets, while simply ignoring future obligations, state governments are willfully deceiving the population at large.

When spending is promised and not funded, current taxpayers never feel the cost of the government services they consume, either willfully or tacitly, through the bureaucracy. Whether politicians want to admit it or not, all spending must be paid for at some point, be it through current taxes, future taxes, or inflation. Moreover, this hides the cost of government from the individual.

This leads to the second issue: generational shifting of debt. When states are unable to fund future retiree pensions, they shift the cost of workers currently providing services from the current generation to future generations. This is problematic, both from a moral standpoint and a practical one. Few people wish for their heirs to be born into debt, and generational debt shifting does just that.

For example, when you factor in the unfunded pension liabilities, each taxpayer in Connecticut owes more than US$48,000. Someone will need to pay down this burden, and the people least likely to do that — current Connecticut workers — are the very same people benefiting from the spending.

Connecticut: The Sinkhole State.
Connecticut: the sinkhole state. (Truth in Accounting)

While Connecticut may well be the worst offender, even states that are traditionally pegged as well run on fiscal issues are guilty. Texas taxpayers face an average burden of about $6,700. Alabama’s taxpayers are more than twice as worse off, with a burden of $14,000.

Why does this happen? What brings eight in 10 states to rack up future debt, while masking the severity of the problem? The answer lies in the incentives of current legislators. The first may well be the most obvious: people who have not been born yet do not vote.

Similarly, but less severe, is the fact that younger voters have very low turnout rates. These combine to give politicians every incentive to promise away money that they simply do not have. The only ones who are losing are the very people that have the least influence on whether a politician continues to hold office.

Moreover, there is staunch resistance to attempts to fix the problems. When liabilities are high enough to either force higher taxes now or spending cuts for current programs, public outrage erupts. This is especially true of public sector pensions, which few people would willingly admit the need to cut.

Public workers are seen as doing good work in the name of, well, the public good. Nobody wants to see their friends’ retirement plans ripped out from under them, be they school teachers, office employees, or police. Yet, something must be done, and the more time that passes, the worse the problem gets.

Finally, there are incentives for pension plans to inflate the expected rate of return on assets in order to minimize the perceived burden that the funds face. This may well be the most dangerous of the issues involved.

Reason Foundation policy analyst Victor Nava had this to say: “Using unrealistic investment return assumptions can be harmful to a pension system, because when the assumed rate of return is not met, the unfunded liability in the pension system is understated. Rosy projections on the books keep the current pension crisis from appearing worse than it really is. A higher assumed rate of return means lower mandatory contributions from the state budget, but it masks the severity of the debt problem.”

States must come to terms with the fact that they are simply spending beyond their means, and must consider both current and future spending obligations when writing their budgets. These bills are never going to go away, and taxpayers, either now or in the future will be forced to pay for them.

We can only hope that legislators quickly come to their senses. Otherwise, it will be our children and grandchildren left holding the check for governments they neither asked for nor benefited from. I don’t know about you, but I think that’s a terrible legacy to leave.

Nick Zaiac Nick Zaiac

Nick Zaiac is a public-policy researcher in Washington, DC. He also serves as a policy analyst at the Maryland Public Policy Institute. His column, The DC Leviathan focuses on the often-ignored bureaucratic agencies, from the Department of the Interior to the General Services Administration. He has been published in the Baltimore Sun, City AM, CapX, and other outlets. Follow @NickZaiac.