I believe it is an important topic for several reasons. Establishing and maintaining a pension plan requires significant financial discipline. Funds have to be set aside today to be used in the future. If this is not done it results in substantial intergenerational inequity. Current needs then need to be sacrificed for what should have been prior expenses.
These factors are particularly acute when public employees are involved. Politicians are predisposed to appeal to voters today rather than worry about the costs of tomorrow. They are also especially susceptible to the pressure of special interest groups. Over the past 50 years, public sector unions have been preeminent among those groups. As a result, pension benefits were often increased while the necessary funds were never set aside for those increased benefits. It was easy to give the benefits away. It was not easy to raise taxes to pay for them.
We are now reaching the point where those bills are coming due. The impact of that financial neglect and irresponsible fiscal discipline will touch many people. Those costs will be high and will undoubtedly result in higher taxes and cuts in current government services. It might also culminate in cuts in pension benefits to public sector retirees if and when the pain of higher taxes and reduced services on the rest of the voters causes the politicians to understand where most of the votes are.
Here are links to recent posts I wrote on the pension issues in Kentucky and Illinois, which are two of the states that are in the worst shape. New Jersey and Connecticut are two other states that are in serious shape.
Another state that faces significant challenges in funding its public sector pension plans is California. Its pension funds are better funded than the four states mentioned above, but the sheer size of the CALPERS (the California Public Employees Retirement Systems) and CALSTRS (California Teachers) pension plans puts California at risk of major financial problems.
CALPERS has approximately $350 billion in assets under management. That is a lot of money but it only represents 69% of what is currently owed to current and future retirees in present value terms.
That means California is short at least $150 billion for is state employees.
CALSTRS is the pension fund for teachers in the state. It was 64% funded at the end of its last fiscal year. It is short almost $100 billion in funds for future pensions.
13D Research recently looked at the public pension issue and concluded that we are near "The End of the Road for America's Pension Crisis". The article suggests that we are so late in the game that only two options now exist for many public pension plans---Implosion or Reform. There is nothing in-between.
13D Research reaches that conclusion by looking at where we are today after a spectacular 9-year bull market in equities.
Consider the fact that the S&P 500 almost tripled in value in the nine years ending December 31, 2017. However, many of the large public sector funds have not made any significant progress in improving their funded status over that period of time.
For example, here is a chart from CALSTRS that shows that the pension fund is essentially at the same funding level as it was in 2009. This has resulted from increasing numbers of teachers retiring and taking their pensions such that the investment funds cannot be replaced fast enough even with fantastic investment returns.
CALSTRS now only has about 1.5 actives for every retiree. It was nearly 6:1 in 1971 and will soon approach 1:1 as the following chart demonstrates.
13D Research asks the question of what happens in California when the inevitable difficult bear market in the stock market occurs?
We had a taste of what is possible last month, when CalPERs lost $18.5 billion in value, or 5% of total assets over a 10-day trading period. The fund has since gained much of that back, but the potential liability remains. Demographic realities mean this liability is deep and intractable. If state pension funds were unable to meet their benefit obligations after a 9-year bull market, how can they if there is a sustained downturn?
However, even without a bear market, California is facing massive increased funding costs to close the current funding gap.
According to a new report from the League of California Cities released after reviewing data for 451 municipalities that use CalPERS to administer their pensions, from fiscal year 2019 to 2025, city payments for pensions will increase an estimated 50%. Pension costs, which consumed an average of 8% of cities’ general fund budgets in 2007, will drain an average 16% by 2025. The bottom line — without tax increases there will be even less money for public services.
However, the new limitation on the deduction of state and local taxes for federal tax purposes is going to make it even more difficult for legislators to solve their problem with tax increases.
Consider this chart prepared by The Brookings Institute that shows the alternatives facing state legislators in the four states highlighted above that would be necessary to fund their public pension problem.
20% tax increases across the board or 20% cuts in direct spending or 500% increases in worker contributions? There are no good choices left in these states.
This is also assuming that stock market returns don't turn negative at some point.
13D Research looks at all of this and comes to the conclusion that public sector employees are going to have to accept pension reform. It is that or implosion.
The public sector unions have had a lot of clout for the last 50 years. I wrote six years ago in "The Bloom Is Off The Rose that the power of those unions had reached an inflection point. I predicted that in the future that public sector unions would no longer be playing offense but they would soon have to spend most of their time playing defense. Public sector pensions would soon come under attack by voters and politicians.
Private sector workers and taxpayers are not going to put up with the rich defined benefit pension plans, early retirement packages, extended sick leave programs, vacation days that get converted into deferred compensation packages at retirement and low cost medical plans that the public sector employee unions now enjoy. Of course, this was all paid for by the private sector workers who, if they ever got any of these bennies, don't have them anymore.
The voters are not willing to pay more in taxes for these outsized benefit programs and they are also not willing to see essential public services cut to pay for rich retirement and other benefit programs.
How serious is it?
Consider that the political columnist for the liberal Los Angeles Times recently wrote a column titled, "Democrats running for California governor need to stop talking about Trump and start talking about public pensions."
A liberal saying to stop talking about Trump and start talking about a real problem?
That is really, really serious.
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