States Pursue a Variety of Remedies to Repair Pension Shortfalls

All you have to do is turn on the TV and/or Internet to know that states and municipalities aren’t sitting on their hands waiting for the federal government to come up with some magic bullet — bankruptcy? — to repair their pension shortfalls.

Pension reform packages stretch from Wisconsin Governor Scott Walker’s proposal to dismantle collective bargaining to New York City’s Mayor Michael Bloomberg’s plan to raise retirement ages, increase employee contributions, eliminate overtime in pension calculations and tweak the final average salary formula for future hires only.

Many states and municipalities, straining under the weight of pension obligations, are capping benefits, directing new workers to 401(k) programs and barring part-time employees from enrolling in the system. There are calls for cutting or shrinking cost of living adjustments for existing retirees but this step, already taken in Colorado, Minnesota and South Dakota, is being tested in court. Many state constitutions make it impossible to claw back benefits for current workers.

The winding down of the massive America Recovery and Reinvestment Act, better known as the federal stimulus plan, is a strong reason why federal bailouts are considered a possibility. Tepid to modest economic growth hasn’t helped either. The Republican-led House is showing no appetite for making federal taxpayers help state and local governments cope with widespread budget problems. Even some Democrats are wary, underscoring the impact of Washington's crushing budget deficits.

Former Florida Governor Jeb Bush and former House Speaker Newt Gingrich promoted the idea of creating a bankruptcy route for fiscally troubled states in an op-ed in the Los Angeles Times last month as a way to head off any calls for federal bailouts.

There are contractual agreements between public employees and the states and any federal solution would abrogate those contracts. Reactions to the federal government allowing states to declare bankruptcy are that it preempts states' authority.

“States and localities want autonomy in dealing with pension funding and are not subject to one-size-fits-all remedies,” says Keith Brainard, research director at the National Association of State Retirement Administrators in Georgetown, Texas. “Moves to come up with a federal solution are misguided.”

Jeffrey Esser, the executive director of the Government Finance Officers Association (GFOA), applauds the National Governors’ Association for opposing federal proposals to allow states to declare bankruptcy. “It is clear that the nation’s governors don’t want, don’t need, and have no intention of declaring bankruptcy.” But he notes that comparing the way public pensions work to private pensions, regulated by ERISA, the Employment Retirement Income Security Act is relevant because states and municipalities can’t go out of business and leave the pension plan to the federal Pension Benefit Guaranty Corp., which insures benefits of participants in underfunded terminated corporate plans — state plans are not safeguarded by the PBGC.

While cities can and have declared bankruptcy — Orange County, Calif. is the largest municipal bankruptcy so far — states can’t default without federal intervention. But during the depression, one state became insolvent. “In 1933, Arkansas went bankrupt and couldn’t meet its bond payments,” notes Elizabeth Kellar, president and CEO of the Center for State and Local Government Excellence (CSLGE). “The state made no investments in infrastructure for 10 years but muni-bond investors were paid in full.” She used this example to undercut any fears municipal bond investors may be experiencing following talk of state bankruptcies.

But what states and municipalities can do — and what Arkansas did in the 1930s — is raise taxes to make up deficits. This is a real sticking point, especially among governors who have pledged not to raise taxes. However, some states are going this route, most notably Illinois, whose state legislature last month voted to raise individual income tax from three to five percent, while hiking corporate taxes from 7.3 to 9.5 percent. Illinois, California and New Jersey have posted the largest pension deficits among states, with California topping out at $535 billion. Pension unfunded liabilities in Illinois total $83 billion; for New Jersey, $53.9 billion.

In Illinois, lawmakers enacted a reform bill that went into effect this year changing the pension system for new employees hired on January 1 or after so they retire with full benefits at 67 instead of 60 and their retirement is to be calculated on a maximum salary of $106,800.

“It’s a mystery why there’s been any talk of the federal government getting into this — they’re not wanted and the talk’s certainly not helpful,” CSLGE’s Kellar says. “There are some pensions that are fully funded, so why would these states and localities want help? It’s not easy to make these changes in pensions but each state and municipality is going about it.”

Even within states that are in trouble, not every pension fund is underfunded. “The Illinois Municipal Retirement System is 84 percent funded, so the problem is not statewide,” she says. State pensions are considered healthy if they are at least 80 percent funded.

Citing the state's sizable unfunded retirement obligations, Standard & Poor's earlier this month downgraded New Jersey's general obligation debt to AA-. Now only two states, California and Illinois, have lower ratings. As S&P wrote in the downgrade, "The lower rating reflects our concern regarding the stresses from the state's poorly funded pension system, substantial postemployment benefit obligations, and above-average debt levels." The emphasis on pension debt reflects a trend among the rating agencies to consider not only a state's immediate budget woes and outstanding bond debt, but also its long-term retirement obligations.

Much of the talk about state bankruptcy has centered on the solvency threat posed by unfunded public pension liabilities of as much as $3 trillion, according to an estimate by Joshua Rauh, associate professor of finance at the Kellogg School of Management of Northwestern University.

Another side of this debate is that roughly one-third of the 19 million state and local employees — those in fifteen states, including California, Texas and Massachusetts — are not eligible for Social Security and depend exclusively on their pensions and personal savings in retirement. Without pensions, public workers who don’t pay into Social Security, have no major source of retirement, which would increase the burden on government programs.

So while most observers do not expect to see any states declare bankruptcy, the threat is giving governors and legislators a powerful weapon for trying to force concessions from public employee unions and the drama is playing out on our TVs.