Government Debt on the Road to Ruin

Nearly every state has followed the same basic policy of making promises today and letting someone figure out how to pay for them years from now.

Americans are addicted to living beyond their means, at least when it comes to the functions of government. That's why the federal debt tripled over the past decade and under President Barack Obama's budget plan would keep growing indefinitely.

Why not? If you don't have to pay for all you get, you're likely to take more than you need.

The problem is hardly confined to Washington. State and local governments can't get away with endless budget deficits because of restrictions on their authority to borrow money. But if you think that keeps them from piling up obligations on future taxpayers, you underestimate their ingenuity.

A common method is setting up generous pensions for government employees while failing to put away the money needed each year to pay the benefits that will inexorably come due. The evidence of where that approach leads is on grim display in Illinois.

Bruce Rauner, the new Republican governor, gave a State of the State address Wednesday that mysteriously failed to address the state's huge public employee pension debt. It's like a biography of George Custer that omits Little Bighorn.

The chance of success is about as small as Custer's. Illinois has a bigger unfunded obligation than any state in the country, exceeding $100 billion and, by some estimates, as high as $250 billion. It has attained that distinction by failures like skipping contributions and assuming the economic good times would never end.

"The deadly combination of nearly 30 years of systematic state underfunding of its employer contributions to the pension systems, followed by the cataclysmic decline in asset values caused by the national meltdown in financial markets over the last year, combined to create an all-time high in the state's unfunded pension liability," said a 2009 governor's task force. These payments now swallow up a quarter of general-fund revenue, at the expense of other programs.

California has a similar problem. Despite the enactment of a modest pension reform bill in 2012, the state controller reported last year that state and local public pension systems now have unfunded liabilities totaling $198 billion—up 30-fold since 2003.

Illinois passed its own mild reform plan, which a state court struck down for violating a constitutional provision that says public pension benefits "shall not be diminished or impaired." If the state Supreme Court agrees, the chance of a true solution will go from slim to none.

If you live in neither of these states, don't assume you are immune. Joshua Rauh, an economist at the Hoover Institution at Stanford University, reports that in the 10 largest cities in America, these obligations have remained swollen despite economic growth and a soaring stock market.

Under the usual accounting standards, they have shrunk less than 2 percent. But under what Rauh regards as a more accurate formula, they have jumped by 40 percent. How did that happen? "Liabilities continued to rise and benefit payments continued to outstrip contributions," he writes.

In a paper published last year in the American Economic Journal: Economic Policy, Rauh and University of Rochester economist Robert Novy-Marx concluded that "with the possible exception of Indiana, there is no state for which the current total contributions by all state and local government entities are greater than the present value of newly accrued benefits."

In time, all these pension gaps can be closed in only two ways: raising taxes or reducing promised payouts. Rauh and Novy-Marx calculate that to put these programs on a sound footing, taxes would have to go up an average of $1,385 per year for every household. In Illinois, the figure is $1,907; in California, it's $1,994. Topping the heap is New York, at $2,250.

Rauner has talked about moving state workers into defined-contribution 401(k)-style pension programs. But that option does nothing to lighten the vast obligations that have already been incurred. And there is a good chance the state courts would disallow it because it would leave these workers with something less than they were promised when they were hired.

Nearly every state has followed the same basic policy of making promises today and letting someone figure out how to pay for them years from now. Illinois may be on the road to ruin, but it's just the lead car in a long parade, passing every exit.