Why the state pension gap keeps growing

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There’s no question that insufficient contributions help explain the $144 billion funding shortfall reported last week for fiscal 2020 by the Illinois Commission on Government Forecasting and Accountability. Last year’s increase in the gap also owes something to poor investment performance at the five state employee pension plans, which all fell short of the 6.5 percent to 7 percent returns they assume.

If Illinois had contributed more to the pension plans over the years, and if the plans had gotten better investment returns, their collective funding ratio would be higher than the dismal 39 percent COGFA reported.

But the focus on these factors obscures the primary driver of Illinois’ pension woes. Reading COGFA’s report, I noticed that pension liabilities increased by $7 billion in 2020, matching the growth of the funding shortfall. 

That’s a revealing parallel. Rising liabilities are the rabbit Illinois has been chasing around the track for decades now. The faster they grow, the harder it is to catch up.

Illinois’ public pension liabilities now stand at $236.5 billion, an increase of 433 percent since 1996. Over the same quarter-century, pension assets rose just 278 percent to $92.3 billion.

Pension liabilities are projected to increase another 39 percent to $327.9 billion by 2045, when the plans are supposed to be 90 percent funded. To achieve that goal, however, Illinois will have to contribute another $363.7 billion in taxpayer dollars to state pension plans between 2021 and 2045, the COGFA report shows.

By 2045, the required annual contribution will double to $19.9 billion from an already-staggering $9.7 billion, nearly a quarter of the 2021 state budget. 

Those contributions could be a lot lower, and the goal of 90 percent funding could be reached sooner, if pension liabilities weren’t growing so rapidly.

A big reason why pension liabilities are rising so fast is the generous raises state retirees are entitled to. They get "cost-of-living" increases of 3 percent every year, regardless of the actual inflation rate. Getting those bumps over the past few decades of minimal inflation has been pretty sweet. Even sweeter is the fact that lawmakers in the early 1990s switched to annual compounding of the 3 percent annual raises.

That turbocharged pension liabilities. Under the "rule of 72," a method for measuring the growth of an amount of money subject to compound interest, a pension increasing at 3 percent annually would double in 24 years.

According to the State Employees Retirement System, COLA accounts for about 28 percent of that plan’s liabilities. The state’s biggest pension plan, the Teachers’ Retirement System, didn’t get back to me with a figure. But if the percentages are similar for all five plans, it’s clear that COLA raises are responsible for a huge share of Illinois state pension liabilities.

Getting rid of COLAs, or at least reducing them, seems like a simple, logical step that would shave billions of dollars off a massive fiscal obligation that threatens to devour the state’s budget. As required pension contributions consume an ever-larger share of state revenue in the years ahead, policymakers will face painful choices between cutting important services and raising Illinois’ already-high tax rate.

You’d think politicians would jump at a chance to ease the pain substantially without spending a dime. But nothing is straightforward in Illinois. For starters, a provision of the state constitution bars any reduction in state pension benefits. A state supreme court ruling left no doubt that eliminating or curbing COLAs would violate that provision.

Then there’s an utter lack of political will to do something about that constitutional provision. Gov. J.B. Pritzker, fearful of state employee unions, insists that any constitutional amendment allowing changes to pensions would violate federal law. He cites no legal precedent for this view and ignores the inconvenient fact that federal courts haven’t struck down Arizona’s amendment of a similar "pension protection clause" in its constitution.

If Pritzker and other state leaders were serious about resolving Illinois’ pension crisis, they’d follow Arizona’s example and put before the voters an amendment to the state constitution that would restrain the growth in pension liabilities. Instead, they seem content to keep digging.

via Crain’s Chicago Business

August 18, 2021 at 05:32PM

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