Governments’ Pension and Retiree Health Obligation Challenges
Many local and state governments and the federal government have accumulated large pension and retiree health care obligations, which stress their annual budgets. The federal government has the biggest obligations for the Social Security and Medicare programs. The ever growing number of baby-boomer aged retirees increases the payouts from these already financially stressed benefit plans and programs.
Many state and local governments are facing financial crises due to underfunded pensions and retiree health care benefit plans. The ability to meet their obligation to public employees, to creditors and most critically to the well-being of their citizens is threatened. It is a national crisis which could lead to huge defaults and bankruptcies of many local governments in the next severe economic downturn.
Different levels of government play very different roles in the provision of public services. The federal government provides for the defense of the nation. It manages the Social Security and Medicare systems. It also collects funds that are shared and sent to the states and local governments for the provision of services.
State governments provide for systems of public education (K-12 and higher education), operate courts of justice and corrections programs, and provide the welfare services funded primarily by the federal government.
Local governments provide most of the services that directly affect people’s quality of life such as public safety (e.g., law enforcement), water and sewer, refuse collection, parks and recreation, etc.[1]
The United States Constitution leaves to states the responsibility for most domestic governmental functions. According to a study done in 2012, state and local governments spend $2.5 trillion annually and employ over 19 million workers — 15 percent of the national total and 6 times as many workers as the federal government. State governments are coping with unprecedented challenges in attempting to provide established levels of service with uncertain and constrained resources[2]. The federal government finances are precarious with a deficit of nearly $30 trillion and huge Social Security and Medicare obligations.
The first wave of baby boomers is at retirement age. Pensions, social security, and retiree health care including Medicare payouts will rise as a result of: the increase in the number of retirees; past underfunding of required contributions to plans through bad accounting practices; and investment earnings on pension assets such as U.S. Treasury bonds that have fallen below assumed rates of return due to the stimulus policies of the Federal Reserve to reduce interest rates to boost the economy.
Pension and retiree health care expenditures of state and local governments are growing at rates that exceed revenues. In a report issued in July 2012, it was disclosed that pension funds for state and local government workers were underfunded by approximately a trillion dollars according to their actuaries and by as much as $3 trillion or more if more conservative investment assumptions were used.[3] In addition, unfunded liabilities for retiree health care benefits for state and local government retirees amounted to more than $1 trillion.
State programs such as Medicaid were growing rapidly because of increasing enrollments, escalating health care costs and difficulty in implementing cost reduction proposals. Medicaid recently surpassed K-12 education as the largest area of states’ spending when all funds, including federal funds, are considered; and Medicaid appears likely to continue to claim a growing share of states’ resources.[4]
The capacity of governments to raise revenues is increasingly impaired. Untaxed transactions are eroding the sales tax base. States restrict the revenue generating ability of their local governments. The federal and state governments have less revenue to share with local governments.
Pressures on local governments, caused by lack of revenues are constraining education spending, law enforcement, and aid to the needy. Local government cuts pose a significant risk to the overall economy and our quality of life.
Compounding the problem for local and state governments is the anti-tax stance of most politicians. Since Ronald Reagan’s presidency in the 1980s taxes have been suppressed. It started with the federal government and then the state government followed. It put more pressure on local governments to provide services without federal and state help. It made it almost impossible for local governments that lost a significant portion of its tax base like Detroit to maintain basic services.
It’s in politicians interests to keep taxes down. Politicians know that proposing tax increases or new taxes will cost them their jobs.
In 43 states, pension statutes were deemed by their constitutions to have created a binding legally enforceable contract between employer and employee. There were more than 3,400 state and local retirement systems in the United States in 2012.
During the 2008 financial market collapse, state and local government retirement funds lost nearly $1 trillion of market value. For example, the funded status of the California Public Employees’ Retirement System (CalPERS), the largest system in the nation, fell from 100.1 percent funded in 2007 to 60.1 percent funded in 2009 on a market-value-of-assets basis.[5]
The City of Chicago and the State of Illinois have significant unfunded pension obligations that threaten their financial stability.[6] In a report dated July 2012, it was disclosed that estimated total unfunded liabilities of the state of Illinois for both pensions and other retiree benefits was $203 billion, including liabilities associated with pension obligation bonds. That worked out to more than $15,800 per capita for the state as a whole.
According to a March 2017 S&P survey of pension obligations, Chicago ranked worst among the nation’s 15 largest cities. In fiscal year 2015, 38 percent of Chicago’s total governmental fund expenditures were for pension and retiree health contributions — representing the highest share of all 15 cities’ budgets.[7] Moody’s Investor Service, downgraded Chicago’s credit rating to junk status, cautioning potential lenders that the City may not be able to pay them back. Chicago was the lowest credit rated major City in the country after Detroit.[8]
The Illinois Supreme Court affirmed the state Constitution’s protection of government workers’ pensions, effectively prohibiting the state and local governments from slashing pensions to balance their budget. In addition, under Illinois state law, municipalities are not allowed to file bankruptcy.
Even though wealth and income were very unequally distributed across the City, Chicago still had a healthy tax base and, unlike Detroit, had no statutory limits on its ability to raise local taxes to pay its retiree obligations.[9]
The Detroit bankruptcy became a model for other politicians seeking an easy fix for their impoverished cities pension and legacy obligations. Since most of these cities had junk bond ratings and could not borrow, a bankruptcy would not hurt them as much. Just the threat of filing for bankruptcy should motivate unions and retirees to make concessions.
The big question in Detroit was why didn’t the state of Michigan put the Detroit Public Schools (DPS) through a bankruptcy? They were in a worse financial condition than the City government, especially after many years of state intervention. The answer was the state would have been obligated to pay the teachers pensions. The unfunded pension liabilities owed to the teachers greatly exceeded Detroit’s unfunded pension obligations. They didn’t want to pay those pension obligations and fight the teacher unions. They didn’t have the political will to do it.
According to Daniel Howes of the Detroit News:
“There is no rejecting the state’s complicity in accumulating a half billion dollars in DPS debt during more than a decade of state control. A chapter 9 bankruptcy of DPS risked establishing a precedent, Kevyn Orr told the governor, that could expose taxpayers to billions of dollars in creditor and pension liabilities — and the possibility that a federal court could order the state to raise taxes to pay them.[10]
The result would be a financial and political cataclysm, the governor told Senate and House Republicans in separate meetings intended to deliver a stern message. Without enough votes to pass the $617 million rescue package for DPS, the administration would be forced to retain bankruptcy counsel in anticipation of filing Chapter 9 on or before June 17, 2016.
Snyder shared the warnings delivered by Orr. School districts across the state would be tempted to follow DPS’ path in an effort to shed liabilities on their books, effectively dumping them on Michigan taxpayers and creating a civic firestorm that would be difficult to control. The Snyder administration told lawmakers the state and DPS could be “on the hook” for between $2 billion and $3.5 billion in pension liabilities. That would equal a cut of $3,000 in state aid for every public school student. A bankruptcy would hurt the state retirement system because it includes Detroit teachers. The credit ratings of the state, DPS and other school districts would be downgraded.
There is scant precedence for school districts filing for bankruptcy, the Snyder administration found. The Richmond Unified School District in Northern California filed for bankruptcy because of $42.5 million in debt. The judge ruled the district could not be protected by the court in bankruptcy and ordered the state to provide the district with operating funds.”[11]
The City of Detroit’s bankruptcy was done as a one-time thing because it had the greatest potential of savings for the state in terms of funding pensions. If the state had been held responsible for funding Detroit’s pensions it would have never allowed the bankruptcy filing.
The federal government is the master of running deficits and borrowing to make ends meet. When the government spends more in a given fiscal year than it brings in through revenues, it runs a deficit. Running a deficit for a long time can be a bad thing for the country’s economy because the interest on borrowed money continues to accrue, exacerbating the long-term debt. The deficit usually increases when the nation is financing a war or is experiencing a recession. Now the fiscal policy seems to be to run deficits to maintain a strong economy. The greater the national debt, the greater the interest on that debt becomes and it squeezes out funding for other services.
Much of the national debt was bought and held by individuals, institutional investment companies and foreign governments. The debt is managed by the U.S. Treasury through its Bureau of the Public Debt. The debt falls into two categories: intragovernmental holdings and debt held by the public.[12]
As significant as Detroit’s debt was, the federal government was in far worse shape. Detroit’s $12 billion debt at the bankruptcy filing amounted to about $17,000 per capita. The U.S. debt held by the public in 2016 was nearly $12 trillion or $38,000 per capita. But including massive unfunded entitlement and other obligations — $12.3 trillion from Social Security, $35.5 trillion from Medicare, $1.8 trillion in intragovernmental debt, $6.3 trillion from federal employee and military retiree benefits, and $1.2 trillion in other liabilities — brought the total U.S. federal debt exposure to $69 trillion. At a per capita level of over $218,000 per person, the federal government’s exposure was more than twelve times that of bankrupt Detroit. In 2021 with massive deficit spending each year since 2016 it is even much greater.
The federal government’s annual budget for FY 2020 was around $5 trillion a year. The largest expenditures were for Social Security, Medicare and Medicaid which combined totaled approximately $2 trillion per year[13]. The federal government’s obligations for Social Security and Medicare appear unsustainable. When the federal government starts to cut expenses the first to be cut will be Social Security and Medicare. It’s the same thing faced in Detroit. Detroit realized it couldn’t afford retiree health care and pensions any longer. Similarly Social Security and Medicare will be the most tempting target for the Feds to cut. The elderly dependent on Social Security and Medicare will be hurt just like Detroit’s retirees were.
The federal deficit and coming financial crisis will make Detroit’s bankruptcy look small. In Detroit we should have seen the disaster coming. It’s equally obvious a fiscal disaster is brewing with the federal government. The Coronavirus pandemic may be the final straw that breaks the U.S. economy.
Social Security is a pay-as-you-go system. Even though there is an estimated nearly $3 trillion in the trust fund, this simply reflects accounting entries of the net surpluses the fund has been credited with, plus interest earned, since inception. There is no actual money in the fund, just the special-issue Treasury bonds, which are in fact government IOUs. The real surpluses have been used by the federal government as a funding source of many things.
In 2018, for the first time since 1982, more social security benefits were paid than revenues collected. This was no surprise to the government, as they projected and forecasted these figures based on the country’s demographics in the annual Trustee Report since 1941.
The Social Security system is now approximately 2 full time equivalent payers for every 1 recipient receiving Social Security benefits, costing the system more than it’s taking in. The birth rates from 1946–1964 peaked in 1957, and were still large each year thereafter through 1964. About 70 percent of the “Baby-Boomers” have not even begun to retire yet, and beginning in 2022 the bulk of that generation will retire in a five to seven-year succession.[14]
On average, federal outlays for Social Security and Medicare made up almost 40 percent of total noninterest spending during the past 10 years, compared with 16 percent 50 years ago. By 2047, under current law, federal spending for people age 65 or older who receive benefits from Social Security, Medicare, and Medicaid would account for about half of all federal noninterest spending, compared with about two-fifths today.[15]
Social Security is the largest single program in the federal budget. It pays benefits to more than 61 million beneficiaries in all. It would take a 4.5% increase in the Social Security tax to provide funding through 2091.
If the Social Security trust funds’ balance declined to zero and current revenues were insufficient to cover benefits specified in law, the Social Security Administration would no longer be permitted to pay beneficiaries the full amounts to which they were entitled when payments were due because other laws prohibit officials from making expenditures in excess of available funds.[16] The Congressional Budget Office (CBO) estimated the amount of the total reduction in annual benefits that would be necessary for outlays to match revenues in each year after the trust funds were exhausted. The required reduction would amount to 28 percent in 2031 and greater percentages in later years.
The can can’t be kicked down the road any longer. We can’t borrow our way out. It is a mathematical certainty that benefits will be cut and taxes will go up.[17] Just like Detroit in 2005 when it borrowed $1.5 billion to fund its pension plans, should we continue to ignore the signs?
[1] CRC, Citizens Research Council of Michigan, “Reforming Statutory State Revenue Sharing”, February 2015
[2] Ravitch Richard and Volcker Paul, “Report of the State Budget Crisis Task Force”, July 2012
[3] Ravitch Richard and Volcker Paul, “Report of the State Budget Crisis Task Force”, July 2012
[4] Ravitch Richard and Volcker Paul, “Report of the State Budget Crisis Task Force”, July 2012
[5] Ravitch Richard and Volcker Paul, “Report of the State Budget Crisis Task Force”, July 2012
[6] Bhatti Saqib, “Why Chicago Won’t Go Bankrupt — And Detroit Didn’t Have To”, June 22, 2015, inthesetimes.com
[7] Snyder Rick, “To protect our future, we must pay past debts”, Nov. 27, 2017, Detroit News
[8] Bhatti Saqib, “Why Chicago Won’t Go Bankrupt — And Detroit Didn’t Have To”, June 22, 2015, inthesetimes.com
[9] Bhatti Saqib, “Why Chicago Won’t Go Bankrupt — And Detroit Didn’t Have To”, June 22, 2015, inthesetimes.com
[10] Howes Daniel, “Bankruptcy for DPS threatens cascading risks”, June 10, 2016, Detroit News
[11] Howes Daniel, “Bankruptcy for DPS threatens cascading risks”, June 10, 2016, Detroit News
[12] Mirza AnZish, “What Are the National Debt, Debt Ceiling and Budget Deficit?”, April 13, 2017, US News and World Report
[13] US Budget of the U.S. Government for Fiscal Year 2019, Table S-4. Proposed Budget by Category.
[14] Walser Rebecca, “Federal Deficit (Detroit Canary in the coal mine) The coming collapse to Social Security as we know it”, December 28, 2018, Opinion FOX Business
[15] US, CONGRESS OF THE UNITED STATES CONGRESSIONAL BUDGET OFFICE, “The 2017 Long-Term Budget Outlook”, March 2017
[16] US, CONGRESS OF THE UNITED STATES CONGRESSIONAL BUDGET OFFICE, “The 2017 Long-Term Budget Outlook”, March 2017
[17] Walser Rebecca, “Federal Deficit (Detroit Canary in the coal mine) The coming collapse to Social Security as we know it”, December 28, 2018, Opinion FOX Business
