Ticking Time Bomb
There are about 4,000 pension plans in the United States that were set up for the benefit of public sector employees. Most of them are underfunded, some disastrously so. Some have no funds at all. They are pay-as-you-go. Deductions from the paychecks of current workers are sent to the bank accounts of former workers.
Except for the charade of Al Gore’s “lockbox”, that’s how Social Security works. In the 80s, payroll taxes were substantially increased in order to create a trust fund in anticipation of the retirement of the baby boom generation. All of the surplus was spent. The trust fund was given T-bills in lieu of cash. Social Security is now paying out more than it takes in–$50 billion a year and projected to rise substantially every year from now on. The T-bills are sold in the open market (or to the Fed) to make up the shortfall. In about 10 years, the charade well will be dry. At which point, benefits will decrease by about 25%, or money will have to come from the general fund to make up the shortfall. Since there will be a lot of old people 10 years from now, and since old people vote, I suspect folks in the workforce will get stiffed.
But that is a problem to be discussed another day. The public sector time bomb will go off even sooner. First, we’ll define what it means to be under water. The time frame in question is the next 30 years, the length of time necessary for the baby boom generation to pass from the scene. The actuarial calculation is as follows: Projected contributions from active employees, plus return on invested capital, minus projected payouts. The published numbers I’ve seen are for the 50 states plus DC. Only DC is fully funded, thanks to you, dear taxpayer. In last place is Illinois, which is 34% funded. The aggregate shortfall, AS REPORTED BY THE TRUSTEES OF THE PLANS, is just under $1 trillion.
But that is a phony number. Federal law requires pension plans to make actuarial calculations using the AA bond rate (about 4% today). The law exempts public plans. They use any rate they please. Most are using 7.5 to 8%. The State of California plan just voted to lower to 7.25%. The contributing entities screamed about the need for additional contributions, and that miniscule reform is therefore being phased in over 3 years to lessen the pain. In addition to wildly optimistic return assumptions, most plans are using unrealistic life expectancy assumptions. Life expectancy has been increasing at the rate of 3 months per year since 1900. No reason to assume that it won’t continue to do so for at least the next 30 years. But most plans assume a lower number. The real shortfall is closer to $3 trillion. My guess is that adding in plans for cities, counties, teachers, and mosquito abatement districts gets the number to AT LEAST $6 trillion. In addition, the Pension Benefit Guarantee Corporation, which insures private pension plans, including all the union backed multi-employer plans that are underwater, is in the hole to the tune of $60 billion.
This ugly situation should be top of mind across the political spectrum. For those who favor activist government, diversion of untold billions to fill the pension hole diverts funds from other government endeavors (and is already doing so in many jurisdictions). For those of us who think the public sector already comprises too large a share of the economy, the prospect of higher taxes (or greater debt) to finance the retirement of public sector employees means less investment in productivity enhancement. Productivity growth is the only source of additional wealth. If we are collectively poorer, it is the poor who will suffer. In almost all instances, the clever/ruthless find a way to make out. There are rich folks in Venezuela today. It is the less clever and less ruthless who will pay the price of a stagnant economy.
My proposed solutions (or, more accurately, mitigations) are as follows:
- Transparency: Force all public plans to publish an accurate accounting, including all the assumptions behind the calculations.
- Good for the gander: Apply the same rules to public and private plans.
- The stick: The SEC should prohibit the sale of Muni bonds by any entity that has not fully funded its pension plan.
- Feet to the fire: Don’t vote for, or contribute to, any politician who is not willing to address this issue head on.
Vallejo, Stockton, Detroit and Puerto Rico were canaries in the fiscal coal mine. We miners need to pay attention. One major component of the gas that caused them to hit the newspaper at the bottom of the cage was underfunded pension plans. Time to get some fresh air in the mine.