If You Think Your State is Broke Now, Just Wait Til The Pension Bomb Explodes!

Unless you've been pulling a Rip Van Winkle for the past few years, you know that your state is more busted than Larry Craig in an airport toilet. The only possible exception is the state of Denial, and it closed its borders to new arrivals sometime in late 2008.

One of the main drivers of this sorry state of affairs is the massive disparity between public-sector and private-sector compensation, especially when it comes to benefits such as pensions. Various studies have found anywhere between a 70 percent and a 34 percent differential in total compensation, with public-sector employees getting not just more pay and benefits but near-absolute job security and early retirement. Consider California, where Reason magazine reports,

"A bipartisan bill...passed virtually without debate unleashed the odious "3 percent at 50" retirement plan in 1999. Under this plan, at age 50 many categories of public employees are eligible for 3 percent of their final year's pay multiplied by the number of years they've worked. So if a police officer starts working at age 20, he can retire at 50 with 90 percent of his final salary until he dies, and then his spouse receives that money for the rest of her life. Even during the economic crisis, "3 percent at 50" and the forces behind it have only become more entrenched.

In the midst of California's 2008--09 fiscal meltdown, with the impact of deluxe public pensions making daily headlines, the city of Fullerton nevertheless sought to retroactively increase the defined-benefit retirement plan for its city employees by a jaw-dropping 25 percent. What's more, the Fullerton City Council negotiated the increase in closed session, outside public view."

Unfunded state pension liabilities run in the neighborhood of $1 trillion.

There is a solution to this mess, the same solution that has been adopted by the private sector over the past several decades: switching from defined-benefit retirement plans to 401(k)-style defined-contribution plans. In a state such as Ohio, which is facing a $8 billion budget deficit and where state and local employees earn about 34 percent more in total compensation than their private-sector counterparts, bringing public-sector compensation into line with the private sector would cut the state's deficit by about 28 percent.

The alternative? Well, there isn't really one, other than destroying your state's economy. The politics of cutting public compensation are never easy but they have also never been more critical.

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"Much bigger increases in employee costs are on the horizon. Thanks to huge unfunded pension and retirement health-care promises granted by past governments, and also to deceptive pension-fund accounting that understated liabilities and overstated future investment returns, California is now saddled with $550 billion of retirement debt.

"The cost of servicing that debt has grown at a rate of more than 15% annually over the last decade. This year, retirement benefits—more than $6 billion—will exceed what the state is spending on higher education. Next year, retirement costs will rise another 15%. In fact, they are destined to grow so much faster than state revenues that they threaten to suck up the money for every other program in the state budget....

"Few Californians in the private sector have $1 million in savings, but that's effectively the retirement account they guarantee to public employees who opt to retire at age 55 and are entitled to a monthly, inflation-protected check of $3,000 for the rest of their lives."

~ Arnold Schwarzenegger writing in the WSJ

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Grouch: Much of the so-called stimulus money has been transfer payments to the state governments to prop-up their finances and save the jobs of state employees.  This preserving of the status quo explains in part why the stimulus quite frankly has not been very stimulating.  Unfortunately, it also delays the painful decisions that face the states and just makes their problems worse.