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We're used to hearing regular reports of U.S. government debt growing to staggering levels. But recent events are spotlighting another huge problem -- the unfunded liabilities of state and local governments that spell future financial chaos.
In early April, Americans by the millions were gripped by the specter of a Federal government shutdown, with members of the Democratic and Republican political parties battling each other over spending priorities. While both sides agree on the need for spending cuts in the face of a projected $1.4 trillion deficit for fiscal 2011, newly elected Republican representatives want a significant rollback of spending, but Democrats are somewhat more selective in the programs they would cut.
Hard on the heels of the looming Federal budget crisis, however, is the growing threat of unfunded liabilities, which threaten to swamp government at all levels in a deepening mire of fiscal impossibility. Promises made decades ago are coming back to haunt cash-strapped governments, leaving them scrambling to fund pension and medical liabilities that have mushroomed out of control in a population increasingly made up of retirees, older citizens and those needing medical care.
The problem has hit state and local governments especially hard. America watched in amazement during February and early March as thousands of Wisconsin teachers and other unionized state employees converged on the state capitol building in Madison to protest Governor Mark Walker's proposal to curtail the collective bargaining rights of state employees.
In scenes reminiscent of the civil rights demonstrations of the 1960s, thousands of Wisconsin school teachers and pro-union supporters marched, shouted slogans and occupied the capitol building, refusing to move until a court order forced them out.
Though the immediate issue centered on collective bargaining rights, a larger issue deals with state government finances. Wisconsin, which prides itself as the home of the American progressive movement, is nearly broke, with a deficit projected to top $3.6 billion for the fiscal year ending June 2013. Walker, the Republican elected governor in last November's Republican sweep, promised drastic reforms aimed at returning the state to fiscal responsibility.
Shortly after taking office, he announced a bold plan to balance the state's budget by requiring that Wisconsin's teachers be responsible for a greater share of their pension and health-care costs. The bill he introduced in the Wisconsin legislature also contained a provision to eliminate collective bargaining over benefits, which the teachers, as well as their supporters in the AFL-CIO union federation, saw as an attempt to break the union.
In sympathy with the teachers and government employee unions, Democratic legislators responded by leaving the state, preventing the needed quorum for a vote they knew they would lose. For three weeks the battle raged, only to reach a sort of climax on March 9 when Wisconsin Republicans found a legal loophole to pass the collective bargaining bill.
Wisconsin has become the poster child for the desperate fiscal plight of state and local governments. Walker's plan to plug the budget shortfall has ignited similar moves in Michigan, Ohio, Indiana and other largely pro-union states, where desperate state legislatures are considering bills similar to the one passed in Wisconsin. As of mid-March, almost 9 out of 10 U.S. states were either experiencing or expected to experience major budget shortfalls.
The bottom line is that local government pensions are on a collision course with reality. A study published in late 2010 by a team of economists at Northwestern University and the University of Chicago warned that mounting pension liabilities "threatened the ability of state and local governments to operate."
Looking closely at data from 77 of the largest municipal defined-benefit pension plans, covering two million public employees and retirees, the study concluded that the estimated liability of all U.S. municipal retirement funds is $574 billion. Of course, the amount of liability varies from city to city. Every household in Chicago, for example, is on the hook for nearly $42,000 for its local pensions, while New York City households face the second-highest liability at nearly $39,000.
The National League of Cities, in its most recent annual survey of fiscal condition, ranked the problem of unfunded liabilities at the top of the list of financial concerns, with mounting employee healthcare costs and pension costs as the major concerns.
The problem is not confined to local governments: States are also facing hundreds of billions of dollars in unfunded liabilities. When local and state liabilities are added together, the figures are staggering. A 2010 study by the respected Pew Foundation put the figure for unfunded liabilities at more than $1 trillion over the next decade, with other studies putting the figure much higher.
Even these figures pale when total U.S. liability is factored in. The total of all of America's debt, added to the monumental long-term commitments of Social Security, Medicare and Medicaid, amounts to, by some estimates, more than $50 trillion-a staggering half million dollars for each American household! The mind simply boggles at such figures.
States and municipalities are waking up to the reality of the problem. In Philadelphia, which is about to run out of money from existing assets, Mayor Michael Nutter defined the city's defined benefit plan as "unsustainable" and announced plans to replace it with a defined contribution plan, which has no payout guarantees.
Small towns are also feeling the pinch. Prichard, Alabama, a small city on the outskirts of Mobile, ran out of money in 2009 in its municipal pension fund. In spite of a state law mandating the payments, Pritchard simply stopped sending out monthly retirement checks to its 150 retirees. The move sent shock waves through the state, while desperate pensioners filed lawsuits to get their benefits.
The growing problem of how to fund billions in pension, retirement and medical benefits has led to a national debate: Are pensions a right guaranteed to state and municipal employees?
Many state constitutions contain language supposedly guaranteeing state pension rights. In Illinois, the legislature recently passed a series of laws reforming the state's pension system that will save hundreds millions over the next decade. But it may be "too little and too late," as many observers doubt this will solve Illinois' budget problems.
Across the country, state and local pension funds are being forced to face harsh economic realities. Recent years have seen swelling numbers of state and municipal employee retirements, while increasing lifespans are lengthening the time pensions must be paid. The rapid rise of U.S. medical costs, which have been increasing at twice the rate of inflation for more than a decade, only exacerbates the problem.
This has occurred while state and local government hiring has stagnated, reducing the number of new workers paying into the systems. And as the United States continues to wallow in economic stagnation, cash-strapped cities and states are forced to lay off thousands of employees who are paying into the retirement and health-care systems.
States and municipalities also are getting squeezed by low interest rates that reduce returns on invested pension funds. For years, most state and municipal fund managers managed to get 7 to 8 percent returns on invested pension funds-a realistic rate until recently.
For example, California's massive California Public Employees Retirement Systems (CalPERS) fund, the nation's largest at more than $200 billion, achieved an annualized return of 7.75 percent for 20 years. But the past two years have seen this return drop dramatically. Though many fund managers are hoping for returns in the 6 to 7 percent range going forward, the economic turmoil of the past two years suggests that even this level of return may be overly optimistic.
It's interesting that many state constitutions mandate payment of pensions, but none of these state constitutions has figured out a way to create money! Unlike the Federal government, which has followed the underhanded policy of endless debt creation, states and cities must balance their budgets each year.
Some states, such as Illinois, have tackled the problem through tax increases on personal and corporate taxes. But wealthy citizens and their businesses are "voting with their feet" and simply leaving high-tax states. As one blogger puts it, "the laws of economics are far less yielding than the law of conspiracy-against-the-taxpayer."
California presents a case in point. If it were a separate nation, California would have the world's eighth-largest economy. Yet, facing a staggering $28 billion budget shortfall over the next 18 months, former Governor Arnold Schwarzenegger declared a state of "economic emergency."
The California Public Policy Center's estimates of funding shortfalls for California's state and local retirees range from $325 billion to nearly $500 billion over the next decade. By contrast, state revenues have averaged $94.5 billion per year over the past five years.
Currently, California's state and local governments employ more than 1.5 million workers, or nearly 5 percent of the state's population. Each of them is entitled to generous pension benefits under the state's defined-benefit plan-one of the most lavish in the nation. Its pension fund, estimated at more than $200 billion, is one of the largest investment pools on Wall Street.
California, recognizing the approaching disaster, passed measures in 2009 and 2010 designed to roll back some of the past decade's increases in public-sector employee pensions and increase employee contributions to the pension funds. But these halfhearted attempts have failed to solve the basic problems, and California is facing, as the Public Policy Center puts it, "a financial implosion."
Late last year, California State Controller John Chiang pointed out the unsettling news that the state's unfunded liability grew by $8.1 trillion during fiscal 2010, an amount nearly equal to 25 percent of the year's entire kindergarten-through-high-school education budget. Clearly, all California did was kick the fiscal can down the road.
Public employee pension plans are increasingly being likened to pyramid schemes, in which "contributions" withheld from those presently working are used to pay benefits to those currently retired or about to retire. The growing fear is that, like all pyramid schemes, those who come in last are the ones who end up losing. In state after state, pension plan "reforms" take the form of reduced pension benefits promised to newer public employees, who are often socked with higher benefits contributions.
Economic and financial observers point to the juicier benefits packages that most government employees receive. A 2010 study by the American Legislative Exchange Council, the nation's largest, nonpartisan voluntary membership organization of state legislators, showed public-sector employees get benefit packages worth far more than those in the private sector.
The study revealed that government employee benefits packages are 69 percent greater than those of private-sector employees and account for most of the roughly $11 per hour more that public-sector employees receive.
These heftier benefits packages, of course, require larger contributions on the part of state and local governments. Figures recently released by the Federal government's Bureau of Labor Statistics showed that state and local government contributions to public employee retirement and health-care benefits totaled $7.64 per hour versus only $2.93 per hour in the private sector.
Observers of all political stripes agree that the problem of massive unfunded liabilities threatens the very economic survival of the nation. Many do not realize that history provides ample lessons of the dangers of national fiscal irresponsibility.
It has often been pointed out that fiscal breakdown was a major cause of the fall of ancient Rome. The 18th-century historian Edward Gibbon cited excessive taxation and spiraling government debt as one of the reasons for the collapse of the most powerful empire of ancient times. In his monumental work The History of the Decline and Fall of the Roman Empire, Gibbon cited demands by the Praetorian Guard for ever-increasing pay and benefits and mounting costs of hiring foreign mercenaries to defend the Empire as leading causes of Rome's fiscal downfall.
Your Bible reveals how ancient Israel went from prosperity to its downfall, also brought on by fiscal irresponsibility. Under King Solomon, Israel enjoyed unprecedented prosperity; money and tribute poured into the Kingdom from surrounding nations that the Israelites either conquered or had treaties with. "So Solomon reigned over all kingdoms from the [Euphrates] River to the land of the Philistines, as far as the border of Egypt. They brought tribute and served Solomon all the days of his life" (1 Kings 4:21).
Yet Solomon sowed the seeds of the country's destruction through immorality and excessive taxation. Shortly after his death, the kingdom split into two nations, Israel and Judah. Under a succession of mostly unrighteous kings that ruled after Solomon, Israel and Judah experienced further high taxation and even paid tribute to surrounding nations.
One of the acts of Jehoiakim, a puppet king who ruled over Judah more than three centuries later, was to tax the people heavily to pay tribute to the Egyptian Pharaoh Necho, who had taken control of Judah. "So Jehoiakim . . . taxed the land to give money according to the command of Pharaoh; he exacted the silver and gold from the people of the land, from everyone according to his assessment, to give it to Pharaoh Necho" (2 Kings 23:35).
Great kingdoms and empires of old never learned the lesson of fiscal responsibility, and it led to their downfall. Just a few short decades ago the United States was the world's greatest lending nation. Now it is the greatest debtor nation in history, with debt increasing at an astronomical rate.
God's warning to ancient Israel of the results of rejecting Him are striking: "The alien who is among you shall rise higher and higher above you, and you shall come down lower and lower. He shall lend to you, but you shall not lend to him; he shall be the head, and you shall be the tail. Moreover all these curses shall come upon you and pursue and overtake you, until you are destroyed, because you did not obey the voice of the Lord your God, to keep His commandments and His statutes which He commanded you" (Deuteronomy 28:43-45, emphasis added).
Ancient Israel and Judah both followed destructive paths, with the result that they were eventually overthrown, their people suffering enslavement to foreign powers. Will the United States suffer the same fate?
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Keywords: U.S. economy debt Wisconsin Walker, Mark California local government debt
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