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Honest-to-goodness pension fix

Re-amortize state’s debt to pension funds

Published: Wednesday, Feb. 13, 2013 1:15 a.m. CDT
Caption
Ralph Martire

There was much wailing and gnashing of teeth when the recent lame-duck session in Springfield ended. Why? No action was taken to address the $95 billion in debt owed to the state’s five pension systems.

This leaves the systems with just 40 percent of funding they should have currently, well below the 80 percent generally deemed healthy for public systems.

Good government groups and editorial boards lamented the Legislature’s failure to pass yet another proposal to reduce that ginormous obligation – this time cutting almost $30 billion in benefits earned by current workers and retirees. 

But rather than being dismayed, folks should be relieved.

The proposal that failed to pass – like every other proposal – focused its solution on benefit cuts and failed to deal with its true cause. 

Three factors contribute to the creation of this unfunded liability.

The first two are items inherent to pension systems themselves, like benefit levels, salary increases and actuarial assumptions; and investment losses suffered during the Great Recession.

If those were the only factors creating the unfunded liability, the systems would be around 70 percent funded today, meaning no crisis.

The vast majority of unfunded liability is made up of the third contributing factor: debt.

For more than 40 years, the state used the pension systems like a credit card, borrowing against what it owed them to cover the cost of providing current services, effectively allowing constituents to consume public services without having to pay the full cost thereof in taxes. 

This irresponsible fiscal practice became such a crutch that it was codified into law in 1994 (P.A. 88-0593). That act implemented such aggressive borrowing against pension contributions to fund services that it grew the unfunded liability more than 350 percent from 1995 to 2010 – by design.

Worse, the repayment schedule it created was so back-loaded it resembles a ski slope, with payments jumping at annual rates that no fiscal system could accommodate.

This year, the total pension payment is $5.1 billion – more than $3.5 billion of debt service. By 2045, that annual payment is scheduled to exceed $17 billion, all growth being debt service.

This unattainable, unaffordable repayment schedule is straining the state’s fiscal system – not pension benefits or losses from the Great Recession.

No matter how much benefits are cut, that debt service will grow at unaffordable rates, which means decision makers can’t solve this problem without re-amortizing the debt. 

Given the current repayment schedule is a complete legal fiction – a creature of statute that doesn’t have any actuarial basis – this change is relatively easy. Re-amortize $85 billion of the unfunded liability into flat, annual debt payments of around $6.9 billion each through 2057.

After inflation, this new, flat, annual payment structure creates a financial obligation for the state that decreases in real terms over time. Because some principal would be front-loaded rather than back-loaded, this re-amortization would cost taxpayers $35 billion less than current law.

One last thing – it actually solves the problem by dealing with its cause.

Note to readers – Ralph Martire is executive director of the Center for Tax and Budget Accountability, a bipartisan fiscal policy think tank based in Chicago. His column is reprinted with permission from Crain’s Chicago Business.

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