By Bill Zettler
I find it more than a little ironic that the media in Illinois is all atwitter about the huge bailout proposed by the US Treasury Department. Headlines in the Tribune, Sun Times and Daily Herald all lament the burden being placed on 300 million taxpayers by the Treasury Department bailout while they completely ignore a like amount due from 15 million Illinois taxpayers to pay for multi-million dollar pensions for retired public employees.
If there has ever been an argument for increased transparency in Illinois it is this comparison: why does everyone know about the $700 billion liability coming from Washington and so few know about the $700 billion liability coming from Springfield?
TV talking heads seem to agree that political donations from Fannie Mae and Freddie Mac to Barack Obama, John Kerry and Chris Dodd in the $100,000 range are unseemly and suspect. However, no mention is made of the $1.9 million donated to Gov. Rod Blagojevich, $1.1 million to the Madigans and $323,000 to Tom Cross by the Illinois teacher unions. According to the Associated Press more than $2.3 million has been contributed by Fannie and Freddie but that pales in comparison to the $35 million plus contributed by the teacher unions to Illinois politicians.
The end result was the same: $700 billion to $1 trillion worth of taxpayer payments due over the coming decades. Only one is in the headlines every day and one is buried in the political closet, hidden and deadly but unrecognized.
I bring this up now because recent financial information has become available supporting my prediction that investment returns by Illinois pension funds will not equal their predicted 8.5% per year. It is becoming more apparent that returns in the area of 6% are more likely. The difference represents more than $100 billion of additional taxpayer funding not currently accounted for.
The TRS (Teachers Retirement System) released a memo outlining how the fund lost 4.9% last year. That makes the last 8 years average 6.3%, not far from Warren Buffets prediction of 6.5% over the coming 20 years or the IRS 6.1% requirement for private pension funds. The difference between an 8.5% return and a 6.3% return over 37 years is about $150 billion taxpayer dollars. Because Warren Buffet says 6.5%, the IRS insists on 6.1%, the last 8 years show 6.3% I think the pension funds 8.5% prediction is a disconnect from reality.
The reasons an 8.5% investment return is unlikely are as follows:
1. The human population will never double again.
This has never been true before but demographers say the world's population will level off at about 11 billion in 2100 from 6+ billion now. This is important because new workers are an important part of economic growth as they work, earn, consume and invest. By contrast, the population doubled between 1960 and 2000 the era of highest economic growth in history.
2. Major economic powers have birth rates below replacement rate.
Economic powerhouses China, Japan, Russia and Europe will all have decreasing populations in the next decades, another historical first. Economic growth will almost certainly slow from past decades.
3. Life expectancy is growing.
Related to number 1 and 2 above, this means more senior citizens supported by fewer workers. For example China's life expectancy has gone from 45 to 80 in just the last 50 years. This means current actuarial assumptions for life expectancy are almost certainly too low, resulting in future pension obligations that will be larger than currently assumed.
4. People are retiring at an earlier age.
Earlier retirement age (Illinois teachers for example) plus longer life expectancy means slower economic growth and more taxes on fewer workers. See 1, 2 and 3 above.
5. All of the above.
All of the above means more income/wealth will need to be transferred via taxes from fewer working/productive people to more non-working/non-productive people thus greatly decreasing investment and economic growth. A given dollar cannot go two places, investment and tax, at the same time. Barack Obama, please take note.
6. Oil prices will never be as low again.
During the greatest economic growth period in history, oil prices were decreasing in real inflation adjusted prices from $80/barrel in 1973 to about $65 with most of that period below $25. This has enabled economic growth because there is a direct correlation between BTU per capita and GDP per capita. If the cost of BTU's goes up the rate of GDP growth will go down. In 1998, during the greatest stock market boom in history, oil hit $10 per barrel. In the coming years, is it more likely that we will hit $10 or $210?
7. Economic engines China and India will slow over the next couple of decades.
As the middle class grows in India and China, the demand for more government services and subsequent taxes will have those economies reverting towards the mean for the growth rate of western countries, which is 0-4%. That leaves only the Muslim crescent from Bangladesh to Morocco and sub-Saharan Africa as potential economic growth engines. I rate the chances of those 2 areas becoming the next China and India as extremely low.
8. The terrorist risk premium.
A dozen terrorists with dirty bombs (let alone nuclear weapons) could simultaneously shut down Manhattan, Toronto, London, Paris, Amsterdam and Berlin causing complete financial chaos and bringing the world economy to a halt. Unstable political entities Iran and Pakistan have nuclear weapons and who knows what they will do. I do not know whether the risk premium is one percent, two percent or more but I do know it is greater than zero.
The other blockbuster financial matter unreported by anyone in Illinois is the $14.2 billion unfunded liability for teacher retirees health insurance. That's not a typo, that's $14 billion on top of the well-known $24 billion unfunded liability for the teacher pensions for a total of $38 billion just for teachers. So far there is no similar calculation for other state pensions but projecting from the TRS numbers it would be another $40 billion. Remember this has always been a taxpayer liability it has just never been reported before this year. What else don't we know?
That huge $14 billion number assumed a 9% growth rate in health care costs which is probably low because state coverage is basically for senior citizens since you have to be retired in order to get it. And it does not take into account the ever increasing number of state retirees which over the last 5 years have increased by more than 4%/yr. In order to be conservative, I have used a 2% insured population growth factor giving 11% growth per year.
So per the attached spreadsheet assuming a 6.5% investment return per year going forward and an 11% per year increase in state funded health care cost for public retirees, total taxpayer cost over the next 37 years will be a staggering $946 BILLION! This is not a made up number this comes from the state actuaries.
On the other hand if we had all public employees on Social Security and 401K with 4% employer contribution our cost would be about $150 billion over the same period, a monumental saving of $800 billion taxpayer dollars.
So Illinois taxpayers, the $700 billion the Federal Government is asking for is about $6,000 per household while the taxpayer amount due for Illinois retired public employees over the next 37 years could easily be $200,000 per household.
Which is the bigger problem? Then why hasn't it been reported?
Bill Zettler is a free-lance writer and consultant specializing in public sector compensation. He can be contacted at this email address. Click here to read more by Mr. Zettler.
