Sarah Krouse in the WSJ writes about underfunded pensions at state and local governments.
When the math no longer works the result is Central Falls, R.I., a city of 19,359. Today, retired police and firefighters are wrestling with the consequences of agreeing to cut their monthly pension checks by as much as 55% when the town was working to escape insolvency. The fiscal situation of the city, which filed for bankruptcy in 2011, has improved, but the retirees aren’t getting their full pensions back.
She points out that the total unfunded liability of these pensions is $5 trillion.
The trouble with deficit spending, as I have pointed out, is that it sets the stage for political conflict. Retirees expect their benefits. Bond-holders expect to get paid back. Taxpayers expect current services. Some groups are going to be disappointed.
It seems like one constitutional reform is to increase the threshold for bills that create or increase mandatory spending to something like two-thirds.
We need something like “usury for local governments”. Creditors shouldn’t be able to lend to these entitites at all except at high risk and with general social suspicion and disdain.
Also, “Systems, Not Goals.” Any outcome that is dependent on actors routinely exercising costly or difficult self-control in the face of regular temptation is doomed to failure, “time inconsistent preferences” and all that. Better to set things up such that the temptation isn’t there at all.
So, a different approach would simply require that any bond be subordinated in priority to every other claim, that is, like a junior unsecured creditor who is only paid in full and on time with the tax revenue that is left after everything else has been paid, with no liens or rights to seek attachment, garnishment, etc.
The practical effect would be to make it impossible for most jurisdictions to borrow at all, except for the most financially sound ones, for the most beneficial projects, or in temporary emergengies, and even then, at high – and often penalty / prohibitive – rates.
Because of the outsized role of finance in our society and economy, the law of credit is one of those rare places where small policy tweaks really can have huge impact on outcomes. For example, if one allowed student loans to be discharged in bankruptcy, or made universities sureties for the debts, the entire system of American Higher Education would experience an overnight revolution.
Sadly, issuing bonds at market rates to raise the cash to cover the underfunding — all that deficit spending being criticized — is the most honest way to mitigate underfunding. It could limit the “scam”, insofar as it places the onus of financing it on the bond buyers.
The “scammier” way is to deflate the value of your liabilities by raising the discount rate used by the plan (equity type risk), but continuing to profess guarantees of payment. Of course, such a guaranteed plan would either require the liabilities to be discounted at AA or so muni rates (which would expose even bigger underfunding) or the purchase of portfolio insuarance to truly immunize future taxpayers from the guaranteed funding risk. The latter is what passes for current municipal pension fund accounting, and the politics allow it — no — encourage it.
Would not some groups be disappointed with a balanced budget?
Seems like everything is working as intended. State and local means you can vote with your feet. Who is stupid enough to move to Illinois or CF?
My concern is that we are only a few years out from a federal bailout of all state and local retirement liabilities. That’s the real storm on the horizon.
At the end of fiscal year 2017, the federal government had its own $3.5 trillion in unfunded civilian and military pension liabilities that are part of a total of about $88.9 trillion in debts, liabilities, and unfunded obligations.
What’s another $3.5 trillion more?
This is essentially a claim about Medicare and SS, which is what, 3/4 of your figure ?
The differences between a local/state liability and the federal government would be:
1) you could lift the cap on payroll tax
2) at some point you can offset with inflation
3) it’s not a pension, so you can raise age of eligibility or make it means tested
What am I missing?
Or in the case of Medicare, change reimbursement rules to reduce payment for a particular treatment by 60-80%.
Not an across-the-board solution, but it does slow growth.
I was citing figures from JustFacts:
“* At the close of the federal government’s 2017 fiscal year (September 30, 2017), the federal government had roughly:
$9.2 trillion ($9,173,000,000,000) in liabilities that are not accounted for in the publicly held national debt, such as federal employee retirement benefits, accounts payable, and environmental/disposal liabilities.[12]
$30.8 trillion ($30,752,000,000,000) in obligations for current Social Security participants above and beyond projected revenues from their payroll and benefit taxes, certain transfers from the general fund of the U.S. Treasury, and assets of the Social Security trust fund.[13] [14]
$34.6 trillion ($34,600,000,000,000) in obligations for current Medicare participants above and beyond projected revenues from their payroll taxes, benefit taxes, premium payments, and assets of the Medicare trust fund.[15] [16]
* The figures above are determined in a manner that approximates how publicly traded companies are required to calculate their liabilities and obligations.[17] [18] [19] The obligations for Social Security and Medicare represent how much money must be immediately placed in interest-bearing investments to cover the projected shortfalls between dedicated revenues and expenditures for all current participants in these programs (both taxpayers and beneficiaries).[20] [21] [22]
* Combining the figures above with the national debt and subtracting the value of federal assets, the federal government had about $88.9 trillion ($88,911,000,000,000) in debts, liabilities, and unfunded obligations at the close of its 2017 fiscal year.[23]
* This $88.9 trillion shortfall is 92% of the combined net worth of all U.S. households and nonprofit organizations, including all assets in savings, real estate, corporate stocks, private businesses, and consumer durable goods such as automobiles and furniture.”
https://www.justfacts.com/nationaldebt.asp#quantifying
But it’s a different situation with local governments, due to exit. It’s not just a question of who is disappointed — a death spiral is a real possibility. People move out or die and are not replaced by new residents (who are, understandably, not eager to assume the burden of paying all those legacy costs in exchange for threadbare services). So property values stagnate or decline, requiring more and more tax increases. Property tax rates reach a level where new construction and even major maintenance (e.g. new roofs) don’t make financial sense (buildings will never be worth the money required to build or rehab them), so decay sets in and many homes and commercial buildings are abandoned. The people who do remain tend to be those who can’t afford to leave, and they tend to require more social services and policing and pay very little in taxes. All of this — not ‘the decline of the auto industry’ — is the real story of the city of Detroit. Property tax rates are now at 3% of market value (on top of a 2.4% local income tax), property values are far below the cost of replacement, and the current downtown construction boomlet is a mirage being fueled by 15-year ‘enterprise zone’ tax breaks that ultimately amount to nearly half the cost of construction and that mean no significant new tax receipts flowing to city from these buildings during the abatement period). At this point, the total value of taxable real-estate in Detroit (a city of just under 700K and that once had 1.8M) is now about a third lower than the total in 40 miles west in Ann Arbor (a city of only 120K).
Yeah, ok, death spirals sometimes happen. The question is, who should bear the burden? The problem with municipal bankruptcy is that, ahead of time, no one really knows how it’s all going to shake out, and so everybody tends to imagine that they won’t be the ones left holding the bag.
But the bag holder should be set in stone ahead of time. “In the event of insufficient funds, X doesn’t get paid.”
And the right X is the lender, who will then have the proper incentive to apply sophisticated and dispassionate scrutiny to the transaction, which will then also serve to discipline spendthrift administrations ahead of time.
Well, bondholders and pension plans should be on equal footing as unsecured creditors. But in the Detroit bankruptcy, the bond-holders did take a much bigger haircut and that’s probably what to expect in future cases. So, yes, buyers of muni bonds should plan accordingly.
Giving the lie to the “it’s just money we owe ourselves” claim.
If I received services based on a promise to pay in the future, and planned to make those future payments based on unreasonable expectation including receiving funds in the future from persons unknown, would people think that that was ok?
I have heard of people who received funds and services based on such promises, and it seems history treats them unkindly. (I am thinking Ponzi, Mugabe, et al)
Perhaps when the promisors are (or were) politicians we should do more to ensure that history treats them unkindly sooner rather than later.
If I received services based on a promise to pay in the future, and planned to make those future payments based on
unreasonableexpectation including receiving funds in the future from persons unknown, would people think that that was ok?With the edit above, it happens all the time. Anytime someone self-employed borrows money, he’s expecting that in the future someone will pay him; that might be a very reasonable expectation or a ridiculous one, but it’s very often entirely reasonable.
So what is reasonable, and what is not?
Didn’t someone once say “Sooner or later, you always run out of other peoples money?”
Nothing new. By now this is a very old story. In Argentina, the discussion started in the 1950s. I remembered how little politicians discussed the new system established in 1958 –a system that even under the country’s demography at that time it was not sustainable (my father died in 1971, just three years after retiring from one of the few good state enterprises with a pension equivalent to 82% of his last salary; my mother died in 1994 and she was supposed to receive a widow’s pension equivalent to 75% of my father’s last salary but most years she received a pension well below that amount). Yes, the 1958 pension system (expanded over the following 15 years to cover at least 60% of men and women over 65 regardless of their “contribution” to the system) was an important source of Argentina’s fiscal crises after 1970. In Chile, they used to have a similar but smaller problem, and after the fiscal crisis of 1975 (due to a large decline in government revenue from copper), they decided to reform the pension system. The reform was preceded by a detailed discussion of alternative systems –including how to deal with the transition– and in May 1981 a new one was established (the new system has been discussed a lot everywhere and you can easily find references to academic research; for the past 12 years, I have been collecting a pension from this system, and you can bet that as long as politicians are kept off the pension funds, the system will be sustainable).
So, if any politician is interested in reforming the pension system while partly protecting past promises, there are ways to do it. The problem is how to compete with politicians that promise to continue funding and expanding the current systems, knowing that to do it they will have to deal with fiscal crises as Argentina has been doing for a long time.
I prefer balanced budgets, but on the federal level, the US government can print its own money.
Until recently, the idea of a national government monetizing national debt was an anathema and considered wildly inflationary.
But today we have seen quantitative easing on three different continents, sometimes in very large amounts in relation to GDP, without inflationary consequence.
It appears that quantitative easing, and possibly even helicopter drops, will present an antidote to heavy federal borrowing.
Unable to print money, state and local governments must be prudent.
You are wrong about QE. It’s not inflationary financing of deficits (a flow) or monetizing national debt (a stock).
QE is a simple intermediation of funds. Banks borrowed from depositors and part of the funds –the part accounted as reserves– are used to finance deficits or pay back outstanding debt. Governments can finance their expenditures by taxing, borrowing, or inflationary financing. QE is borrowing, it is not inflationary financing.
That confusion has been possible because monetarists don’t accept how wrong they are about the impossibility of having a money defined as to comply with monetarism’s two basic assumptions.
I’m surprised that some readers claim that they prefer balanced budgets. To have a balanced budget every year means that all expenditures are financed by taxation. Leaving aside the problem of how terrible all tax systems are, a balanced budget would require ex-ante to estimate with a high degree of precision the annual tax revenue and to have means to limit expenditure to no more than 95% of that estimate. Easy to say, difficult to do. More important, the initial conditions for most governments at all levels in the vertical structure of government of most countries are such that to achieve balanced budgets would require a large increase in tax revenue or a large reduction in expenditure. Again, easy to say, difficult to do.
From my long experience with Argentina and Chile (since 1958 in my home country and since 1973 in Chile, plus work in several other countries for short periods of time), I have learned that once governments have to deal with larger expenditures and deficits over many years, one should also pay attention to how the composition of expenditures change. To accommodate expenditures in new programs (and also in financing new factions and constituencies), expenditures in old programs and services are reduced (even worst, in each old program and service, an increasing share of funds is used to pay salaries and benefits of old employees). The failure of economists to understand politics and government is shown in calls for new government programs without taking into account what we can easily learn from post-WWII experiences in constitutional democracies and other systems of politics and government.
While Handle is mostly right that bondholders should get lower priority, the reality is that doing so virtually ends municipal ability to borrow in its current form. The actual real problem the usual political promises to spend gov’t cash now, and collect taxes later, combined with the very easy pension promise of more cash later.
Certainly a “balanced budget” would help; but local politicians don’t hand out as much cash goodies as they want, that way.
Excessive pensions are such an important case, they should handled differently: If the median wage paid, according to IRS receipts, was ~$60 k/year, it should be clear that pensions higher than this amount are “excessive”. For all pensions over this amount, which is most of them, there should be a couple of requirements. A) The receiver agrees to live in the area or give up half of the “excess”. B) The receiver understands that the excess pensions are subject to financial stress reductions whenever the local authority does not have a balanced budget. C) In financial stress situations, there will be an increasing Stress Surtax lost by the pensioner and retained by the payer under stress, this progressive Surtax goes up as the excess goes up. (Perhaps 10%, 20%, 30% on the amount over median, or 2*median, or 3*median…)
The Federal USA should pass a “local bankruptcy” law which sets out how much the pensioners, especially the excess pension receivers, should lose as compared to how much the bondholders should lose.
The more the gov’t workers lose, the better I feel — because so many Teachers, Police, and other local gov’t workers continually ask for more pay and especially job security, plus more in pensions. They promote fiscal irresponsibility.
Fat cat muni bond holders, usually getting tax-free bond interest, are also to blame, and they should get a haircut, too.
Losses for the irresponsible will help wise on-lookers learn from “other people’s mistakes”. This is perhaps the most important way that market capitalism helps improve the world; the decisions made by those who lose in the market are most often not repeated by those who didn’t lose, and don’t want to.