Pension Woe Mounts As States Forsake Reform

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With its feeble pension legislation last month, California joined a big club of states loudly proclaiming reforms that, in fact, do little to solve a problem that now stretches into the trillions of dollars.

Since 2009, more than 40 states have reported enacting some manner of changes to their pension systems to save money. But pension debt keeps rising and annual payments to pension systems from government budgets are spiking in many places, in part because many of these so-called reforms are superficial in nature.

A recent study by the Pew Center on the States entitled The Widening Gap, which used state pension funds' own annual statements, calculated that from 2008 to 2010 (the latest data) unfunded pension and retiree health care liabilities grew by 38 percent to $1.38 trillion. Using a more conservative assumption about investment returns that reflects market realities, American Enterprise Institute scholar Andrew Biggs recently estimated pension liabilities alone have soared to $4.6 trillion, up nearly $2 trillion since 2008.

The latest poor investment returns likely make those numbers considerably worse. Over the summer, our biggest public retirement funds reported meager returns, including the largest fund, the California Public Employees' Retirement System (CalPERS), which clocked in at a mere 1 percent gain for the year ended June 30. The average among all public pension funds was 1.1 percent, compared to anticipated returns of between 7.5 percent and 8 percent. With funds already paying out more than $200 billion a year in benefits and 14.5 million government workers accruing new retirement credits, the cost of fixing government pension systems amid such scanty returns gets steeper every day.

One strategy of states and cities has been to make changes that apply only to new employees, and then proclaim big savings that don't actually occur for years. The California bill, passed on the last day of August after unions' legislative allies watered it down, largely impacts workers hired on Jan. 1, 2013 and after. By some estimates the bill would save about $50 billion over 30 years in a state where unfunded liabilities are estimated between $250 billion and $500 billion.

This is nothing new. In 2010 and 2011, 23 states raised the retirement age for new workers and increased the number of years those employees must work before qualifying for retirement benefits, according to the National Conference of State Legislatures. But the states left benefits untouched for the vast majority of their workforce.

The savings make only a small dent in future costs. When New York State created a less expensive pension system for new state and municipal workers this spring but kept lavish benefits in place for current workers, legislators predicted the savings would include $21 billion for New York City alone over the next 30 years. Sound impressive? Not so much when you consider that according to the city's own projections, it will have to contribute $359 billion to its pension funds over that time.

New York's political leaders confined their pension adjustments to new workers because of a provision in the state's constitution that prohibits any changes to benefit levels for current workers. Other states have enacted similarly impractical laws. Illinois' constitution, for instance, says that membership in a state pension system "shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired."

Critics of such laws say it is time to challenge them in court or change them because meaningful savings are impossible without reforms to current worker benefits. The Chicago law firm Sidley Austin, for instance, issued an opinion earlier this year that Illinois' constitutional clause on contractual relationships protects benefits already earned by current employees, but not their right to continue earning those benefits at the same rate for their entire careers. Some legislators have urged Illinois to pass pension reform and let the courts decide the issue.

New Jersey legislators want to go a step further after the state's Supreme Court ruled in July that recently enacted reforms to judges' pensions are unconstitutional because state law prohibits cutting a judge's salary. The state's Democratic legislative leaders and its Republican governor, Chris Christie, have announced plans to change the state's constitution as a result of the ruling. Other states with similar costly protections against changes in workers retirement plans could do the same, and may eventually have to.

Politicians have also sometimes used reform as a short-term budget saving tool. Eight states enacted legislation last year requiring employees to contribute more to their pensions, but then governments cut their own pension contributions. In Maryland, for instance, the state is taking $120 million that it is saving from higher contributions from employees and using it to help balance its budget. Maryland's government employee pension funds, however, could use the money. They are just 64 percent funded by the generous accounting standards that the state uses, but only about 40-to-50 percent funded using a more realistic accounting that assumes modest future stock market gains.

A few states have shown that real reform is possible. After the steep stock market decline of 2008, Utah's pension system went from 95 percent funded to 87 percent. Utah's legislature then voted in 2010 to close down its defined benefit pensions to new workers and open a 401(k) style plan in which the state contributes to individual employee retirement accounts. According to a recent analysis by Brigham Young University professors Kerk L. Phillips and Richard W. Evans, if Utah had kept its old plan in place it faced a 50 percent probability that it would go bankrupt in 20 years. Under the new system, that risk shrinks to just 10 percent.

Rhode Island extensively revamped it pension system in 2011. The state suspended annual cost-of-living adjustments for retirees and placed all current workers in a new hybrid pension plan that provides workers with a small defined benefit pension combined with a 401(k) style plan in which workers can save toward their own retirement in individual accounts. The plan was so sweeping that the state estimates it cut the pension system's unfunded liabilities of $6 billion in half. State Treasurer Gina Raimondo lobbied for its passage by telling residents, "This is about math, not politics."

Even if states enacted Rhode Island-style reforms, taxpayers would still be left with substantial unfunded pension liabilities, plus nearly another $1 trillion in future health care promises that governments have yet to fund. Without serious reform, the bill to pay off state and local retirement promises is so staggering that the idea of doing so with some combination of tax increases and stock market gains seems increasingly more unlikely with every day that goes by.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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