Will state pension crisis be the tipping point?

The Supercommittee has come and gone without reaching an agreement on reducing our nation’s debt. Most of the post-mortems focused on who was to blame for the breakdown. If we had been able to slash the projected deficit by trillions of dollars, according to conventional analysis, Washington might have been able to get our debt under control and the United States would be on the path back to a firm fiscal footing.

But the dirty little secret is that it may not have been sufficient to avoid a coming fiscal catastrophe. The thing that pushes the United States over the tipping point just might be the exploding state pension crisis.

This crisis that has been a long time coming and we are just beginning to grasp the magnitude of the state pension debt tsunami that’s going to hit us within the next decade. Because virtually all states have some type of balanced budget requirement, it has been relatively easy to ignore the fact that unfunded pension obligations have been purposefully left off state balance sheets. In truth, those obligations in most states far exceed the total of outstanding state debt, spending, and tax revenues combined.

Credible estimates of the total amount of unfunded state pension liabilities range from $2.5 trillion to more than $3 trillion. Part of the problem in coming up with an accurate estimate is that budget transparency requirements vary greatly by state, and many governments have become adept at hiding the problem with questionable accounting rules that wouldn’t pass muster in the private sector. As a businessman, I know that a necessary first step in running a successful organization is to be honest in your bookkeeping.

It is clear that many states are now teetering on the brink of bankruptcy as a result of pension promises made to employees, the enormous bill for which is just beginning to come due. The Fiscal Times reported last year on the relative health of states’ pensions. The strongest systems are found in New York and Wisconsin. New York mandates fully funded pensions and although it is has the second largest system, rightly funds its pension in good economic times and in bad. The weakest systems are those of West Virginia, Oklahoma and Illinois. It is true that in the last two years, 41 states have made some change to their pension plans to reduce the problem of underfunding, but in most cases, much more needs to be done. The truth is that states need to strengthen their systems across the board - even the strongest pension systems should be improved – just as New York recently did with its “Tier 6” reform plan.

That’s because according to Professor Joshua Rauh of the Kellogg School of Management, even using states’ excessive investment return assumptions, 17 states will run out of pension funds over the next ten years. Over 40 states will run out within the next 20 years. Inevitably, bankrupt states with huge pension obligations will look to the federal government to make up the difference. Are we prepared to offer a rescue to these states that will make the bailouts of the last few years look insignificant by comparison?

And who, exactly, will be coming to the rescue? The answer is clear: taxpayers in states that don’t have a pension deficit will be on the hook for the irresponsibility of states that unwisely promised overly-generous retirement benefits—promises they now find impossible to keep.

Talk about too big to fail: the pressure to “save the states” will be enormous, and unless protections are set in place now, it will simply amount to a transfer of wealth from more responsible states like New York to reckless states like Illinois.

The best approach is to implement safeguards now that will improve the future solvency of these pension plans. For example, perhaps a condition for receiving federal funds should be a thorough reform of state accounting practices and a requirement that states meet their constitutional balanced budget requirements by including pension obligations on their current balance sheets. This kind of positive reform will help ensure that the era of federal government bailouts has truly ended and not just begun.

Hanna, a Republican, represents the 24th Congressional District of New York.

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