Is a $1 Trillion Bailout Ahead for State Pension Funds?

Wednesday, May 19, 2010

The budget woes facing U.S. states may not be as overwhelming as the troubles in Greece. But in a new paper, Northwestern University economist Joshua Rauh says at least seven states are heading toward crushing crises — of the magnitude that would require U.S. bailouts in the next decade — from one cause: state pension liabilities.
In some state constitutions, promised pension benefits to state and local government workers take a higher priority than general obligation bonds. Rauh, with the University of Chicago’s Robert Novy-Marx, previously estimated that state pension liabilities stood at $3 trillion at the end of 2008 compared to $1 trillion in other forms of debt.
Even if pension funds received 8% annual returns, many large states would run so short — without any overhaul today — that raising state taxes to make up for it would be insufficient, he says. Illinois, for instance, would run out of money in its three primary pension funds by 2018. In the years after, the payments owed to existing state workers would be $14 billion, or more than half of the total revenue Illinois projects in 2010.
Other state pension funds expected to dry up by 2020: Louisiana, New Jersey, Connecticut, Indiana, Oklahoma and Hawaii. By 2030, 31 states could be in similar trouble, Rauh said in a report released Wednesday. He says the ultimate cost of a federal rescue could top $1 trillion. “This scenario could happen sooner if taxpayers flee to other states with lower taxes and higher services, if contributions are deferred or not made, or if returns are lower than expected,” he said.
His prescription: Allow states to issue tax-subsidized pension funding bonds — similar to the Build America Bonds programs — for the next 15 years if they agree to major reforms. States would need to close defined-benefit pension plans and offer new hires a defined-contribution plans as well as guaranteed access to Social Security (which only a quarter of all public workers contribute to now). The net cost to the federal government, he estimates, would be about $75 billion.