Across the states, America’s public employee pension plans are a ticking, insolvent time bomb.
“For most states,” the Pew State Fiscal Health Project said in July 2022, “unfunded pension liabilities are the largest of three major long-term obligations weighing on their future finances.”
Things have likely improved since the end of the lockdowns, but in fiscal year 2019 – the last for which the state-by-state data is available – “states owed a total of $1.25 trillion in unfunded pension benefits.”
You don’t hear much about this, but it’s a big problem in big blue states like Illinois, California, and New York, which the American Legislative Exchange Council’s most recent “Rich States, Poor States” report pegged dead last as its fiscal health goes.
In general, these fiscal concerns have not arisen because there’s not enough revenue coming in. After the Trump tax cuts went into effect, the feds were awash in money. Revenues were well over what was predicted had the tax cuts not become law. The problem is spending. Even where balanced budgets are required, the politicians find ways to spend more than comes in.
When a crisis hits, like the lockdowns that shuttered businesses and communities for months during the pandemic, economic activity slowed, and millions of Americans went on relief.
That bill is coming due. Yet policymakers keep hiding their heads in the sand, pretending we won’t notice how dangerous the underfunded public employee pension plans are until the problem lands on someone else’s desk.
It’s something that should concern us all. If one of these plans were to fail, the calls for a federal bailout would be deafening. People would look to Uncle Sam to make retirees who lost their pensions whole. But it won’t stop there. It ends only when taxpayers from well-managed states are left holding the bag, subsidizing the mistakes made by bad managers and incautious voters.
To their credit, fund managers have been experimenting with ways to generate greater returns for defined benefit plans. That’s led some of them into the private equity market. Conceptually, that’s a good idea, though it’s not without risk.
In California, the state’s Public Employee Retirement System plunged into private equity a few years ago, only to see returns drop in 2022. On the other hand, Oregon’s public employee pension system did the same and did quite well.
Being able to tell the difference between a good investment and a bad one is crucial to a plan’s financial health. Prudent management is essential since more than a tenth of all public pension dollars are now invested in private equity.
If the boards that oversee these plans and the firms that manage them do an adequate job comparing the possible risks and rewards, a process known as due diligence – then there’s little to worry about. If they don’t, U.S. taxpayers could be on the hook for making right what they did wrong.
That’s a precedent no one should want to set. Risk and investment go hand in hand. Fund managers are trustees responsible for producing the greatest return on investment possible for their clients. They are responsible for asking tough questions, but they don’t have the same skin in the game as those whose money they invest. They make money either way.
You don’t fix that by banning or limiting pension plans to so-called safe investments like government bonds. That would be like using a howitzer to kill a house fly. Instead, to lessen the need for future bailouts, America’s state and local governments should overhaul how public sector employees save for retirement. Rather than offer defined benefit plans like the ones Pew says teeter on the edge of insolvency, the public sector should shift to defined contribution plans that mirror what exists in the private sector.
It’s a simple solution. It won’t be easy to implement because it threatens the power of the public employee unions. However, offering all state and local government new hires the option of enrolling in a private system modeled on IRAs and 401Ks will protect the taxpayers and give workers a chance to make a greater return on their investment than they can under the current system.
America’s public sector economy is riddled with debt, full of unfunded obligations, and teetering on the brink of insolvency. Still, the politicians do little to take it on. Eventually, they’re going to have to face facts. Public pension reform is an excellent place to start doing the heavy lifting.
Peter Roff is former U.S. News and World Report contributing editor and UPI senior political writer is now affiliated with several DC-based public policy organizations. He writes for numerous publications and appears regularly on international television talking about U.S. politics.