State Pensions Could Be the Next Big Government Bailout

Neither Barack Obama nor Mitt Romney have discussed the looming state pension fund crisis.

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Kristina Rasmussen is executive vice president of the Illinois Policy Institute

Now that the presidential debates are over, Americans have heard President Barack Obama and former Gov. Mitt Romney spar over an array of bailouts: auto bailouts, housing bailouts, bank bailouts, green industry bailouts and so on.

The bailout not mentioned? A bailout of state pension systems, which is on the horizon unless politicians up-and-down the government food chain get their act in order. A bailout would reward irresponsible states at the expense of responsible ones while setting a massive and destructive transfer of wealth in motion.

[See a collection of political cartoons on the economy.]

Pensions costs are growing at an unsustainable rate. State-run pension systems are underfunded by $2.8 trillion according to a recent report from Congress's Joint Economic Committee. Mounting pension payments are crowding out funds for core government services (think roads, safety, education) while putting pressure on maxed-out taxpayers.

Government unions have made it clear they will fight any and all attempts to rein in pension costs. And the politicians who rely on union campaign contributions and get-out-the-vote machines won't want to upset the apple cart.

The easier road for state and local leaders is to seek assistance from the federal government. This isn't an unthinkable proposition—it's happened in recent years with education budgets and Medicaid funding under the guise of "stimulus" spending. Why shouldn't pensions go the same way?

[Read the U.S. News debate: Does Stimulus Spending Work?]

Illinois is a classic example of a system gone haywire with few ways out. Politicians overpromised on benefits and underdelivered on funding. The result? New accounting rules put Illinois's pension debt at more than $200 billion—six times the state's annual budget.

Take Illinois' largest fund, the Teachers' Retirement System. Between now and 2045, the Teachers' Retirement System will pay $376 billion to retired teachers. The fund has just $36 billion on hand. For these assets to cover future payouts, the retirement system would need to see average investment returns of more than 18.5 percent per year.

The system is officially banking on an 8.5 percent annual return, but just-released figures for fiscal year 2012 show a return of less than 1 percent. Less than 1 percent. As one commentator pointed out, that's less than some checking accounts nowadays. For all intensive purposes the fund is insolvent.

[See a collection of political cartoons on the budget and deficit.]

Everyone knows that teachers are a potent political force. Regardless of reform lip service, Illinois's Democratic leaders don't really want to deliver strong medicine to a core constituency; for proof, look no further than the Chicago Teachers Union's recent double-digit pay increase.

Beyond Illinois, too few states are tackling their pension liabilities head on. The nation is on the cusp of the pension crisis, and no one quite knows how it will shake out.

The most obvious form a federal bailout could take is direct assistance. The Illinois Policy Institute put together an online calculator at showing which states would "win" or "lose" from a scenario based on a combination of tax hikes and spending cuts. Users can input detailed changes and get county-by-county results.

[Read the U.S. News debate: Has the Federal Reserve Overstepped Its Mandate?]

Other voices have floated the idea of securing federal guarantees for state pension debt. Illinois Gov. Pat Quinn brought up the idea with U.S. Treasury Secretary Timothy Geithner, according to a 2009 Crain's Chicago Business article. Since then, Governor Quinn has refused to rule out seeking or accepting a bailout.

New and unexpected bailout arrangements will continue to emerge from policy thinkers. Case in point, three professors from Stanford Law School just penned an op-ed in the New York Times calling for the Federal Reserve to use quantitative easing to purchase state and municipal bonds. Even they expect criticism for "unfairly bail[ing] out states and municipalities that have been profligate in the past."