Pension costs: The fiscal challenge for states and cities that new administrations will have to confront

After Election Day, political ads go away; public policy issues do not. Newly-elected governors, mayors, and county administrators in many communities across the nation will find the passing of election day brings them another day closer to having to confront a growing pension crisis. 

We’ve written about a Manhattan Institute study showing how pension costs are crowding out education spending, Oregon’s $22 billion unfunded pension promises, and about reports that necessary new infrastructure spending is being deferred because of, among other factors, pension liabilities.

Add to the mix a recent report from the Center for Retirement Research. Among the findings, as reported by the Associated Press.

Five states need to put aside more than 25 percent of their annual tax revenues just to pay pensions and other debts, an untenable amount, according to a recent study by the nonprofit Center for Retirement Research. For major cities, debt costs above 40 percent of revenue are typically an unmanageable burden, and the report counts eight of them.

Think of that: 25 percent of annual tax revenues to pay for past services! As we’ve noted, Washington state and local governments are in relatively good shape; although, being in relatively good shape considering the magnitude of the problems across the country doesn’t mean we’re not without challenges. 

Several reforms have been proposed here.

One idea that has been suggested involved moving from a defined benefit plan to the defined contribution plans common in the private sector. The proposal failed to gain traction, in part because of concerns with transition problems.

A reform that did take hold involved assuming a more realistic rate of return on pension investments. 

The AP story examined the problems excessive pension liabilities pose for public employees, bond-holders, and taxpayers. No one fares well. The story quotes Tracy Gordon, a senior fellow with the Urban-Brookings Tax Policy Center:

“Someone has to be left holding the bag.”

The CRR report concludes:

The good news is that the total costs for long-term commitments – pensions, OPEBs, and debt service – appear to be under control in many jurisdictions. However, for a handful of states, counties, and cities, these costs are an extraordinarily high percentage of own-source revenue. These jurisdictions have only unpalatable options.

The question of course is what the worst-off states, counties, and cities can do to improve their situation. Four options exist. One is to pray for higher returns. Unfortunately returns would have to be consistently in the 10-15 percent range for the next 30 years to solve the problem – an unlikely outcome given today’s financial markets. A second option is to raise taxes to meet the required commitments. Unfortunately, many of the states with the greatest burden already have relatively high taxes. A third option is to cut other spending by 10 to 20 percent. A final option is to raise employee contributions even beyond what they are already contributing to their plans. Clearly, those governments in the worst shape face an enormous challenge.

True. We would add that, while the worst-off states may experience the consequences sooner and most sharply, a problem of this magnitude often has spillover effects with national implications.