Washington Post blogger Ezra Klein is fond of describing our government as an insurance conglomerate protected by a large, standing army. It’s a pithy way of making the point that our government is defined by what it spends its money on, and in the case of the federal government that is largely Medicare, Medicaid, and the military.
But what about state governments? How should we define them? If it were based on the average interaction a citizen has with their state and local governments we would typically think of it as a service provider – they educate our children, pave our roads, collect our trash, and protect our streets. But this quaint view of where our taxpayer dollars are going is quickly being tossed out the window due to the growing cost of underfunded public sector benefit programs. In Klein’s terms, our state government is quickly becoming a publicly funded retirement community for well-heeled government workers.
A new report by the Pew Center on the States found that the state funds devoted to paying pension and health care benefits to retired government workers is $1.26 trillion underfunded. Even that eye-popping number likely understates the problem. As Pew explains in their report, “The $1.26 trillion figure is based on states’ own actuarial assumptions. Most use an 8 percent discount rate – the investment target that states expect to earn, on average, in future years.” If the last decade is any guide, the 8 percent rate is wildly optimistic. From 2000 to 2009, the average annual return for the pension investments was 3.9 percent.
Using a more likely rate of return, the funding shortfall could be as much as $1.8 trillion, using investment assumptions required in the private sector by the Financial Accounting Standards Board, or even $2.4 trillion, using a conservative rate analogous to the 30-year Treasury bond which guaranteed a 4.38 percent return.
As the funding gap grows the annual bill for pension and health care benefits will continue to climb. “In many states, the bill for public-sector retirement benefits already threatens strained budgets and is competing for resources with other critical needs, including education, infrastructure and health care,” said Susan Urah, managing director of the Pew Center on the States.
This could lead states into the dire fiscal mess being experienced in California and Illinois where growing public sector retiree costs are eroding spending on other programs. In an op-ed last August California governor Arnold Schwarzenegger revealed the starling truth that the cost of retirement benefits was growing so fast that it would exceed what the state was spending on higher education this year. But it wouldn’t stop there, next year costs would rise another 15 percent – far outstripping any growth in revenue. By 2020, annual pension spending will have grown nearly five-fold, from $6 billion in 2011 to $28 billion.
This is a direct threat to taxpayers. As Mercatus researcher Veronique de Rugy explains, “Once pensions plans run out of money, payments will have to come out of general funds, meaning taxpayers’ pockets.” Even now, an exorbitant amount of taxpayer money is going to outsized public sector salaries, lavish benefits, and cushy retirement plans, taking money away from states’ ability to fund Medicaid, schools, and other programs.
Reforms will not be accomplished unless there is some public outrage at this gross mismanagement of taxpayer funds. I have a feeling most people wouldn’t be happy to know state governments are becoming little more than an exclusive retirement resort for their own workers.