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 One Chicago-based think tank is claiming an accounting game can
solve Illinois’ worst-in-the-nation pension problem. And Illinois’ incoming
governor may be taking it seriously.
Fitch Ratings, a credit ratings agency, warned that the plan could lead to
further deterioration of the state’s near-junk credit rating. In the warning,
Fitch echoed concerns voiced earlier by the Illinois Policy Institute.
The plan – pushed by the Center for Tax and Budget Accountability, or CTBA –
fails to reform the system and risks repeating many of the mistakes that got
Illinois into its pension mess to begin with.
The plan relies on massive new borrowing from pension obligation bonds, which
both professional government finance organizations and ratings agencies warn
against, and keeps the systems more underfunded for longer by reducing the
funding target to 70 percent from 90 percent and extending the repayment ramp.
Springfield-based political blogger Rich Miller posted a response from CTBA that
paints the group’s plan as an even worse deal for taxpayers than it originally
appeared to be.
First, according to Daniel Hertz from the CTBA, getting an arbitrage benefit –
or betting that the rate of return on pension fund investments is higher than
the yield on the bond debt, thus saving money in the long term – is not even a
goal of the plan.
Second, Fitch researchers noted that the CTBA plan uses proceeds from pension
obligation bonds for budget relief. But Hertz claims the plan does not. He’s
wrong, and here’s why:
While the CTBA plan actually makes pension contributions more expensive for
taxpayers in the short run, it explicitly decreases contributions in the long
run by lowering the funding target and extending the payment schedule. This is
part of the basis for Fitch’s warning against the CTBA plan.
But the CTBA’s response gets even stranger from there.
Hertz acknowledges that a national recession is becoming “increasingly likely,”
as the U.S. is currently in the 10th year of one of the longest economic
expansions on record and a yield curve inversion, which often predicts
recessions, appears imminent. This means now is the worst time to consider a
pension obligation bond, since the arbitrage gamble seems sure to fail as
investment returns for pension funds fall during a recession. CTBA’s plan is
equivalent to going all in on a blackjack hand when you know the dealer has 21.
Finally, Hertz correctly notes pension payments are crowding out Illinois’
ability to provide core government services, but the CTBA plan is the opposite
of what the state should do to ensure those services aren’t swallowed up by
pension costs.
The reason for this is that the CTBA plan trades “soft debt” for “hard debt.”
Pension benefits are soft debt, as they can be reduced through policy reform.
Meanwhile, hard debt cannot be reduced except in the unlikely event of state
bankruptcy.
The CTBA’s trade would mean prioritizing pension-related payments over core
government spending on social services and education. Additionally, the CTBA
plan makes pensions nearly $2 billion more expensive annually for at least a
decade, accelerating the crowding out effect.
Fitch is right to warn lawmakers against adopting this reckless plan.
Unfortunately, Gov.-elect J.B. Pritzker is said to be “looking seriously” at
this plan as a means of addressing the state’s $130 billion to $250 billion in
unfunded pension liabilities.
Pritzker should abandon this no-reform pension proposal and instead support
meaningful pension reform that starts with a constitutional amendment to allow
changes to future, unearned benefits. Here are four reasons to reject the CTBA
proposal:
1) The CTBA plan increases, not decreases, the cost of pensions in the short
term
Even if the CTBA plan works as designed – which is unlikely for reasons detailed
below – required contributions would increase for more than a decade compared to
current law. According to CTBA’s projections, total pension costs would have
increased for fiscal years 2019 through 2031 if the plan had been implemented
for this year’s budget.
The requirement to increase rather than decrease pension contributions makes the
CTBA plan a bad deal for taxpayers right off the bat for two key reasons.
First, total pension related expenditures already exceed 25 percent of the
state’s general revenue. Pensions as a share of total expenditures have been
rising rapidly for decades, crowding out spending on core government services
such as education and social services.
Illinois’ inability to both deliver essential services and
consistently make the actuarially required pension contributions is a leading
cause of its worst in the nation credit rating.
Second, Pritzker campaigned on increasing spending for numerous government
programs, as well as creating several new programs. Broadly speaking, Pritzker
has promised to spend more for infrastructure, education and social services.
As governor, Pritzker’s ability to fulfill these promises will depend on his
ability to reduce the share of the budget going toward paying for yesterday’s
government in the form of pensions.
According to WTTW, Pritzker has committed to balanced budgets without an income
tax hike for his first two budget years. That is an achievable goal, but not if
Pritzker adopts the CTBA pension plan requiring him to put nearly $2 billion
more toward annual pension costs.
2) The CTBA plan violates best practices for pension funding according to
actuaries
Illinois law currently requires the state to make contributions sufficient to
reach a funding ratio of 90 percent by the year 2045. This standard already
violates best practices set by the Actuarial Standards Board, which publishes
uniform Actuarial Standards of Practice, or ASOPs.
The Illinois state actuary, part of the Office of the Auditor General, has
consistently recommended adopting a funding plan in line with generally accepted
actuarial principles. Specifically, the recommendation is for the state to move
toward a repayment schedule that targets 100 percent funding over a period of no
more than 20 years.
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The CTBA plan moves in the opposite direction both
by reducing the funding target and by increasing the timeline for
repayment of pension debt well beyond the acceptable 20-year period.
In other words, CTBA is supporting the same sort of kicking the can
down the road that got Illinois into its pension mess. From the
Edgar ramp to “asset smoothing,” Illinois has a long history of
asking the next generation to pay the bill. As pointed out by
actuary Elizabeth Bauer in Forbes, the CTBA plan is nothing more
than a plan to keep the system more underfunded for longer.
3) The CTBA plan requires borrowing money through pension obligation
bonds
At a time when borrowing costs are higher than ever as a result of
Illinois’ worst-in-the-nation credit rating, the CTBA plan requires
selling $11.2 billion in new bonds.
Pension obligation bonds, or POBs, are a gamble with taxpayer money.
Theoretically, POBs can save money via arbitrage, meaning the return
on investment from pumping the new money into pension funds is
higher than the interest paid on the bonds. In practice, this rarely
works out. Citing a history of failure, credit ratings agency S&P
Global Ratings considers the use of POBs to be a credit negative,
according to an article published by OFI Global.
According to the most recent projections of Illinois’ last
experiment with POBs, the total of $17.2 billion in borrowing –
racked up under former Govs. Pat Quinn and Rod Blagojevich – will
cost $30.8 billion to repay.
The Government Finance Officers Association, a nonpartisan
professional services organization, has also come out against the
use of POBs, citing the risk involved and history of failure.
Illinois cannot afford to gamble with taxpayer money when the state
already has $7 billion in short term debt from unpaid bills and a
structural deficit of at least $1.2 billion.
4) The CTBA plan does nothing to change the underlying cause of
Illinois’ pension problem
Public debate around pensions is often backward-facing. Was this
problem caused by underfunding or overpromising? This common
question misses a simple truth: One follows from the other.
If someone took out a $1 million mortgage on a $40,000 annual
income, the monthly mortgage payment would be $3,800 using today’s
standard interest rate. Meanwhile, the borrower’s take-home pay
after taxes would be just $2,650 per month. He would miss his
payment every month. When the bank comes to repossess the home, is
it because the borrower overpromised or underfunded his mortgage?
Clearly, both answers hold some degree of truth. But underfunding is
a result of the fact that the required payments were unrealistic
given the borrower’s ability to pay. According to Wirepoints, total
pension liabilities, or the present value of current and future
promised benefits, have grown 4.5 times faster than Illinoisans’
personal income and six times faster than state revenues since 1987.
This means pension benefits are outpacing their funding source.
Defined-benefit pension systems also have several fundamental
structural flaws.
First, the reliance of these systems on predictions about the future
– such as expected rates of investment return, retiree mortality
rates, and future salary and employment levels – make them
unpredictable for lawmakers and prone to fiscal shocks during
recessions. It’s exactly this vulnerability to differing assumptions
that explains why Moody’s Investors Service estimates Illinois’
pension debt at $250 billion, nearly double the state’s official
number.
Second, the amount an employee receives in retirement benefits is
unconnected to the amount he or she pays in to the system. In fact,
most workers contribute only about 4 to 8 percent of what they
receive in retirement benefits – 8 to 16 percent including
investment returns – and half will receive pensions worth over $1
million during the course of their retirement
CTBA’s plan includes absolutely no reforms to reduce the growth in
pension liabilties going forward and no reforms to make the systems
more predictable or sustainable. As a result, the CTBA proposal
cannot be called a pension reform plan at all. It risks a future in
which Illinois is in exactly the same position it’s in today if
benefits grow faster than expected, which is not an unlikely
scenario.
A better path for Pritzker to follow
The 2013 effort to reform Illinois pensions provides a better road
map for Pritzker to solve Illinois’ pension crisis and free up
revenue for his desired spending. The plan was passed through a
Democrat-controlled General Assembly and signed by Democratic former
Gov. Pat Quinn.
Under the reform bill state lawmakers passed in 2013, no current
worker would have received less than she is currently promised, and
no retiree would have seen her monthly check decrease. The reform
concepts – modifying cost-of-living adjustments, increasing
retirement ages for younger workers and capping the maximum
pensionable salary – would have only affected the rate of future
benefit accruals.
While the measure was imperfect, the 2013 reforms would have had
dramatic and positive effects on the state budget.
Unfortunately, the Illinois Supreme Court struck down the reforms in
2015, citing the state constitution’s restrictive pension clause.
Had the reforms survived, they would have reduced the state’s 2016
pension contribution by $1.2 billion and put the state on a path
toward a more sustainable and affordable pension system.
A recent report from the Illinois Policy Institute lays out a path
for building on and improving the 2013 reform model, starting with a
constitutional amendment to protect earned benefits but allowing
changes in the rate of future benefit accruals.
Without real pension reform, Illinoisans face a future in which
state and local governments ask taxpayers to pay more for less, with
continuing calls for tax hikes amid service cuts to pay for
pensions. This is already happening in cities including Harvey,
Peoria, Rockford, Chicago and Springfield, to name a few.
CTBA’s plan does nothing to solve the problem. Pritzker should
disavow the no-reform plan and propose one that effectively
addresses the crisis.
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