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Sit up and take notice, Washington – the future of America’s entitlements is unfolding before you in the form of the Illinois pension crisis. Illinois’ five state-funded pension systems were almost $100 billion too small to meet promised pension obligations, potentially affecting state employees, “down-state” teachers (Chicago teachers have their own pension problems), state university employees and even General Assembly members. The underlying problem is an unrealistic defined-benefit plan, which uses a set formula to determine payments on an individual basis. Such a plan could, for instance, offer benefits of 1% of the employee’s most recent salary, for such a period of time as the employee worked for the state. For example, a 25-year veteran of the Parks and Recreation department, making $50,000 annually at the time of retirement would receive $500 per month for the next 25 years. Defined-benefit programs create massive budgetary problems for state legislatures, because there’s no truly dependable way to measure their eventual cost. Rises in the average wage, increased longevity of workers, and expansion of the state workforce can render original budget predictions useless.
This is exactly Illinois’ problem. Economic and actuarial forecasts for the pension plan have proven amazingly inaccurate, and so have investment predictions. And don’t think this problem is somehow related to the 2008 crash – Illinois lawmakers have been trying and failing to deal with this problem for years. In 1996, then-Governor Jim Edgar, in conjunction with the Legislature, instituted a “pension ramp,” or a graduated set of annual pension payments that were supposed to return the pension fund to solvency by 2045. Of course, within ten years Illinois lawmakers were exploiting the fund to make up for other budget liabilities – providing the government with “pension holidays” that enabled them to “skip” payments. The notable exception occurs in 2004, when a $7.3 billion pension bond sale resulted in a much larger payment than projected. Later bond sales also helped the state continue to exceed projections (at least on paper). Unfortunately, those sales also got Illinois charged with securities fraud, amidst federal allegations that the state had misled investors on state pension forecasts. Yes, in a shocking twist, then-Gov. Rod Blagojevich and his administration lied.
The upshot of a very complicated backstory is this: taxpayers actually paid $8 billion more into the plan than was projected – yet the fund is still broke. Actuarial inaccuracy and unrealistic investment expectations have eaten every bit of that profit and then some. The problem is now too large for even Illinois to ignore, and to top it all off, Illinois’ constitution prohibits the diminishment of public-employee pensions (See Article XIII, Section 5.) With that in mind, lawmakers have a few options if they want to stick with the current defined-benefit plan:1) The Legislature can choose to renege on promises made to current and former employees. The Illinois House passed a plan that would limit cost-of-living increases in pension pay, which are a huge factor in the fund’s budgetary problems. Unfortunately, even if the plan eventually becomes law, it’s likely to be challenged in court on constitutional grounds.2) Lawmakers can also try and raise enough revenue to bridge the gap. Given the failure of previous attempts at this solution, though (see above), this probably isn’t a realistic solution – either financially or politically. 3) Slashing spending elsewhere to cover the liability is also theoretically an option. However, not only is this a non-starter politically, but the entire Illinois budget for FY2014 only comprises $62.4 billion. So even if the state spent nothing for the next year – laid off every employee, closed every building, ended every entitlement – the state would still be at least $40 billion short next year (even assuming the pension liability saw no growth).
Clearly, the Illinois pension program is completely unsustainable, and the Legislature has no choice but to reform the system. Unfortunately, America as a whole hasn’t seen the last of this problem. Most of the problems present in the Illinois system are scarily similar to issues currently dogging Social Security. Social Security, too, is a defined-benefit plan, and it too has suffered from poor actuarial projections and a beneficiary pool that’s living much longer than any before. Social Security runs a deficit as well – by 2020, the fund is estimated to be $95 billion short, and it could collapse entirely by 2033. Washington has got to take a lesson from the president’s home state – entitlement spending is the elephant in the room that can’t be ignored much longer. Just like in Illinois, simply slashing spending or raising revenue alone isn’t going to cover the astronomical costs of American entitlements. Simply reneging on promises isn’t really an option either – even if all of Congress were willing to sacrifice themselves politically, the federal government is still going to be on the hook for Social Security at least.
The Land of Lincoln is learning the hard way what happens when politicians ignore a debt crisis and substitute manufactured solutions for real answers. Let’s hope Washington gets the message now, so we don’t have to relive the Illinois nightmare on a much larger scale.