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Taxpayers Threatened By Growing State Pension Shortfall

by Brandon Greife / /

Washington Post blogger Ezra Klein is fond of describingour government as an insurance conglomerate protected by a large, standingarmy. It’s a pithy way of making the point that our government is defined bywhat it spends its money on, and in the case of the federal government that islargely Medicare, Medicaid, and the military.

But what about state governments? How should we define them? If it werebased on the average interaction a citizen has with their state and localgovernments we would typically think of it as a service provider – they educateour children, pave our roads, collect our trash, and protect our streets. Butthis quaint view of where our taxpayer dollars are going is quickly beingtossed out the window due to the growing cost of underfunded public sectorbenefit programs. In Klein’s terms, our state government is quickly becoming apublicly funded retirement community for well-heeled government workers.

A new report by the PewCenter on the States found that the state funds devoted to paying pensionand health care benefits to retired government workers is $1.26 trillionunderfunded. Even that eye-popping number likely understates the problem. AsPew explains in their report, “The $1.26 trillion figure is based on states’own actuarial assumptions. Most use an 8 percent discount rate – the investmenttarget that states expect to earn, on average, in future years.” If the lastdecade is any guide, the 8 percent rate is wildly optimistic. From 2000 to2009, 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 muchas $1.8 trillion, using investment assumptions required in the private sectorby the Financial Accounting Standards Board, or even $2.4 trillion, using aconservative rate analogous to the 30-year Treasury bond which guaranteed a4.38 percent return.

As the funding gap grows the annual bill for pension and health carebenefits will continue to climb. “In many states, the bill for public-sectorretirement benefits already threatens strained budgets and is competing forresources with other critical needs, including education, infrastructure andhealth care,” saidSusan Urah, managing director of the Pew Center on the States.  

This could lead states into the dire fiscal mess being experienced inCalifornia and Illinois where growing public sector retiree costs are erodingspending on other programs. In an op-edlast August California governor Arnold Schwarzenegger revealed the starlingtruth that the cost of retirement benefits was growing so fast that it wouldexceed what the state was spending on higher education this year. But it wouldn’t stop there, next year costs would riseanother 15 percent – far outstripping any growth in revenue. By 2020, annualpension 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 deRugy explains,“Once pensions plans run out of money, payments will have to come out ofgeneral funds, meaning taxpayers’ pockets.” Even now, an exorbitant amount oftaxpayer money is going to outsized public sector salaries, lavish benefits,and cushy retirement plans, taking money away from states’ ability to fundMedicaid, schools, and other programs.

Reforms will not be accomplished unless there is some public outrage at thisgross mismanagement of taxpayer funds. I have a feeling most people wouldn’t behappy to know state governments are becoming little more than an exclusiveretirement resort for their own workers.