Any Pension Reform MUST Limit Taxpayer Liability

From the archive:

The 5% of Illinois workers who are in the state pension systems cannot have an unlimited claim on the 95% who are not.

The one huge problem with the current pension system is the completely one-sided nature of the risk assigned to each party. As currently constituted the state pension systems limit employees contributions to about 8% of their salary. That is the limit of their risk. They will get their pensions no matter what the cost but they will never have to pay more than 8% of their salary into the pension system.

The calculation for the pension dollars required is 2nd grade arithmetic:

Pensions Dollars Required
Employee Contributions (EE)
Employer Contributions (ER)
Return on Investment (ROI)

That’s pretty simple, right? Everybody can understand the math.

In a perfect world by 2045 total pension payouts would be paid by about 8% of salary from the Employees, 9% of salary from the Employers and 27% of salary from an 8.5% Return on Investment. Add those up and you see in 2045 we need contributions from the three sources of 44% of payroll to meet the pension demands.

That also shows that 60% of the money we need to pay pensions in 2045 comes from investment returns.

The problem arises because the first item, Employee Contribution, is fixed at about 8%. The other two (Employer Contribution and ROI) are not fixed and between them must make up for any shortage in the Pensions Dollars Required. That means if investment returns are not up to snuff the taxpayer, the ultimate Employer of all public employees, must make up the difference.

This is why in the current environment 38% of payroll is being paid for pensions and 30% of the 38% is from the taxpayer. And as bad as that appears, it is a best-case scenario that will, because of looming changes in pension accounting rules, increase to 45 or 50% by 2014. That means taxpayers paying an employee $100,000 in 2014 will also have to pay about $42,000 or more for his pension as opposed to the employees approximate pension payment of $8,000.

It is obvious that having taxpayers/employers paying 5 times as much into the pension system as the employee is not only unsustainable it’s unacceptable.

Any private company paying 40% of payroll into pensions would be bankrupt.

The typical private company pays about 11% for it’s pension contribution, 6.2% Social Security and 5% 401K. It knows going forward what its pension costs will be next year and 5 years from now. It does not vary because of stock market returns or the vagaries of politicians looking for votes. Therefore they can plan going forward.

For the state of Illinois on the other hand, we are forced to pay about $5.5 billion into the pension plan this year in order to make our 2nd grade arithmetic problem above balance. That’s because the amount paid out in pensions is fixed by law, the amount paid in by employees is fixed by law, leaving us taxpayers/employers with all the excess risk of bad investments.

If we were on the Social Security/ 401k system our payout this year would be $2 billion, which means we are paying $3.5 billion more into pensions than we should be forcing $3.5 billion in cuts in other public programs.

Just because Illinois is a public entity does not mean it is not bankrupt.

The argument used by union officials and actuaries is that states cannot go bankrupt because they can always raise taxes to pay their bills. That may have been true at one time but no longer. This is a new economic world where tens of trillions of dollars of wealth have disappeared and can no longer be taxed either at the local, state or federal level. It has become politically impossible to liquidate taxpayers’ balance sheets any further because they have already been largely liquidated by the world’s immense economic problems.

Here is a recent quote from Fidelity Investments:

“The current economy has forced some workers to borrow from their 401(k) accounts in order to pay for critical living expenses, ultimately jeopardizing their future retirement,” said James MacDonald, president of workplace investing for Fidelity Investments.

So are politicians going to tell these people they will need to take more money out of their 410K’s to pay higher taxes so public employees can retire as millionaires in their 50’s? I don’t think so. Legislating higher taxes to make public employees millionaires would be an act of political self-immolation.

The next governor should declare Illinois to be in a state of de-facto bankruptcy requiring a radical financial house cleaning.

  1. Fix taxpayer contribution to pensions at 12% of employee salary.
  2. Limit public employee salaries to $10,000/mo for five years including educators, the governor and his assistants.
  3. All other public salaries cut by 10%.
  4. Freeze education spending at 2000 levels with all money going to school districts with average teacher salaries below Illinois’ median family income ($65,000).
  5. Suspend payments to the pension fund until state revenues and expenditures are in balance a la Chris Christy in NJ.
  6. Alternatively, give the pension funds newly issued Illinois bonds in lieu of cash payments. If Illinois survives financially, they will get their money, if not it doesn’t make any difference.
  7. Suspend pension Cost of Living Adjustments.
  8. Tax all state pensions above $20,000/yr.
  9. Make all pension payments above the Illinois median family income ($65,000/yr) in the form of state IOU’s paying zero interest for 5 years and 2 % in subsequent years. Again, if the state survives you will get your money if not you won’t get paid anyway.
  10. Liquidate all state assets that can be sold for a profit; say 10 times cash flow.
  11. Lease to the highest bidder oil/gas rights in the New Albany shale gas fields in eastern Illinois.
  12. Suspend all “green credits” until further notice. No more taxpayer subsidized windmills.
  13. Double or triple the deer-hunting season to increase revenue and decrease the deer/car accident rate to 10,000 per year from 25,000 per year saving lives and $50 million per year in accident damage.

Bill Zettler is a free-lance writer and consultant specializing in public sector compensation. He can be contacted at this email address.

This article originally posted August 23, 2010.