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 Illinois has the worst pension crisis in the nation, an ugly
reality that is aggravated by the state’s sunny projections that things aren’t
quite as bad today and won’t be as dire tomorrow as the numbers reveal.
During the past decade, the state consistently underestimated how fast pension
costs and pension debt would grow in the future. That left taxpayers on the hook
for $7.6 billion in unexpected costs. It also left social services on the
chopping block and some policymakers with the impression that the pension
problem could simply blow over.
Most of all, these flawed numbers have allowed Illinois’ political leaders to
continue making promises they cannot keep while ignoring a pressing need for
reform.
So far the only pension fix proposed by Gov. J.B. Pritzker is to add $200
million to the pension funds. He only plans to add that money if voters in
November agree to let the state take another $3.7 billion out of the economy by
approving his “fair tax” proposal.
There is a solution to Illinois’ public pension woes, but it starts with real
numbers and a constitutional amendment.
The pension problem
Pension costs have overwhelmed the Illinois budget and swallowed up spending on
core government services. Pension contributions now consume over 25% of the
state’s general funds budget, up from less than 4% during the years 1990 through
1997.
State spending on public pensions has increased by more than 500% during the
past 20 years, after adjusting for inflation. All other spending, including
social spending for the disadvantaged, was down 32% since 2000.
In one example of this hollowing out of state government, the Chicago Tribune
reported almost 20,000 adults with disabilities are awaiting admittance to
programs funded by the state that would help them live on their own. The average
waiting time is seven years.
In the current school year, 36% of the money the state allocates to education
will be diverted to pension payments. This represents a 200% increase in
spending on teacher pensions since 2000, compared with only a 20% increase on
classroom spending during that period.
Despite massive funding increases and diminishing social services, the five
state-run retirement systems – which serve teachers, state workers, public
university employees, judges and members of the Illinois General Assembly – are
only about 40% funded, a shortfall of $137 billion by the state’s accounting.
Unfortunately, the state’s pension hole is likely even deeper than the state
admits.
Moody’s Investors Service calculated Illinois’ pension debt is not $137 billion
but much higher at $241 billion. A key difference is Moody’s uses more
conservative investment return assumptions similar to what are used in the
private sector, around 4%, compared to the state-run plans that assume 6.5% to
7% returns.
Based on the Moody’s number, Illinois’ pension debt was equal to 500% of the
state’s revenues in fiscal year 2018and almost 30% of the entire state economy,
both the highest rates in the nation. If Illinois used more realistic
assumptions, it would need to double the amount it spends on retirement benefits
annually to 51% of the state’s revenues, according to Michael Cembalest, an
expert at J.P. Morgan.
So how can independent analysts come up with numbers that are so vastly
different from the state’s?
A history of rosy predictions
Using overly optimistic investment assumptions allows Illinois to both hide the
true nature of its current pension debt and make projections about future
contributions and the growth in pension debt that are not realistic.
This has been the case for at least the past 10 years, with projections failing
to account for:
A year such as 2009 when the five pension systems realized investments losses of
19.7% to 22.7%
Five other years from 2008 to 2019 when investment returns were well below
assumptions or the pension systems suffered lossesThe five state pension systems
predicted in 2006 that the state would need to make $3.5 billion in combined
pension contributions in 2010. But the state ended up contributing more than
$4.1 billion in 2010, or $634 million higher than the systems predicted.
This pattern repeated itself during the next nine years. During the 10-year
period of 2010-2019, pension contributions to the five systems were $7.6 billion
higher than what the systems predicted in their five-year forecasts for each
plan – a 15.4% average annual difference.
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Pension contributions during this period were based
on the so-called “Edgar ramp,” a 50-year payment plan resulting from
1994 legislation signed into law by then-Gov. Jim Edgar, which
artificially lowered pension payments for 15 years before gradually
increasing them. Well-run pension plans would have used a 20- to
30-year payment schedule that actuaries recommend to achieve 100%
funding rather than the Edgar ramp’s 90% target after 50 years.
After the initial 15-year period, Illinois continued to make
contributions below actuarial levels. In other words, even though
Illinois was making contributions far higher than what the plans
predicted was necessary, the state still wasn’t keeping up with what
actuaries said was needed to keep the systems afloat.
From 2010-2019, Illinois contributed almost $18 billion less than
what actuaries said was required to keep pension debt from growing.
That contributed to the growth in pension debt that accelerated more
quickly than the pension systems’ five-year projections.
It’s important to note that underfunding is not the cause of
Illinois’ pension crisis, but a symptom of the fact that full
payments are unaffordable.
Illinois state and local governments spend the most in the nation on
pensions as a percentage of total revenues – about double the
national average – and compared to the size of the state’s economy.
Illinois’ pension debt is equal to about one-third of what the
state’s economy produces in a year. Pension debts in
2012 and 2013 were 82% and 54% higher, respectively, than projected
five years earlier. Those projections were made in 2007 and 2008,
before the financial crisis that caused pension investments to
plummet in value. That should be a cautionary tale about future
projections that don’t factor in an economic downturn, which is the
case in Illinois. These projections are likely to be
as inaccurate as they have been during the past 10 years.
The state continues to use overly optimistic rates of investment
returns and does not take into account any downturn in financial
markets.
While no one can predict the future, there will almost certainly be
multiple recessions between now and 2045, when the state pension
plans are scheduled to hit 90% funding targets.
A progressive income tax will not solve Illinois’ pension crisis
Gov. J.B. Pritzker refuses to support any pension reform, even an
adjustment to the guaranteed 3% annual compounded increase in
benefits, and has claimed that a proposed progressive income tax
would, if passed, allow the state to pay down its pension debt.
Illinois cannot solve the problem by raising taxes only on
higher-income earners through a progressive tax. Pritzker has
promised at least $10 billion in new spending even though his
progressive tax will generate only $3.7 billion in new revenue. The
math does not support the claim that a progressive tax will solve
the pension crisis. In reality, only $200 million of the new revenue
has been tagged for higher pension contributions.
A progressive tax that would actually raise enough revenue to pay
off the state’s unfunded pension liability would need to
significantly raise taxes on everyone, rather than just the top 3%
as has been promised. A tax hike of the size necessary to solve the
problem could cost Illinois’ economy nearly 127,000 jobs and $21.8
billion in lost gross domestic product.
Previous
income tax increases were supposed to solve Illinois’ fiscal woes,
but never did. A temporary tax increase in 1989 became permanent.
Another temporary tax increase in 2011 that was supposed to
partially sunset led to a record income tax hike in 2017, which also
failed to alter the trajectory of pension debt. The crisis does not
stem from a revenue problem.
Even strong investment returns have failed to solve the crisis.
While the S&P 500 index tripled in value after July 2009, Illinois’
pension shortfall worsened by 75%, Wirepoints has noted.
Increased taxes, optimistic projections and strong investment
returns will not fix Illinois’ pension debt crisis.
Until the state addresses the problem through constitutional pension
reform that preserves earned benefits while curbing the growth in
future liabilities, contributions to its five pension systems will
continue to burden Illinois taxpayers and crowd out spending for
core government services on which Illinoisans depend.
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