Eileen Norcross is a senior research fellow with the Mercatus Center at George Mason University.
Gov. Scott Walker's victory in the Wisconsin recall is a small triumph for fiscal reality over political convenience. His common sense reforms are an attempt to fix a basic problem confronting many state and local governments: how to maintain current services for taxpayers while paying for employee benefits. Leaders only have a few choices: reduce employee costs, lay off workers, raise taxes or debt, or ask the federal government for another bailout—that is, share the bill for state and local collective bargaining agreements with future U.S. taxpayers.
State and local budgets across the nation have a basic accounting problem. The cost of employee benefits is rising fast relative to current revenues. And worse yet, the tab to fund pensions is steeper than government accounts recognize. States report an unfunded pension liability of $800 billion; financial economists estimate the damage is closer to $4 trillion. Public pensions are in many cases poorly funded and retiree health benefits are largely pay-as-you-go. When a worker retires, his or her healthcare is paid for from the annual budget. The pressure is being felt everywhere from Rhode Island to California, Illinois, and New Jersey.
Instead of succumbing to the temptation to close a $3.6 billion budget gap with more debt or gimmicks, Governor Walker ended a public worker health insurance monopoly, saving millions in state aid. And by limiting what unions could negotiate for at the collective bargaining table, he ended overtime padding, a contributor to bloated pension payouts.
That same week, San Jose and San Diego voted to reduce worker pensions after costs began to consume 20 percent of general funds. Measure B in San Jose lets workers keep their accrued benefits, but asks they contribute 16 percent of salary going forward. In San Diego, the city is switching to a defined contribution plan for new hires and freezing salary increases for current workers to save on pension costs.
These cost savings measures aren't popular with workers, but governments are finding they have little choice. In New Jersey, a judge ruled on May 25 in favor of Gov. Chris Christie's pension reforms, ensuring that Cost of Living Adjustments can be frozen for retirees. This is expected to save $80 billion over 30 years. It may sound draconian—after all, Cost of Living Adjustments provide retirees with inflation-protection and are a valuable piece of a retiree's monthly pension check. But consider New Jersey's $200 billion funding gap in its pension systems. If it isn't fixed, retirees stand to lose a lot more.
By basing annual payments to the pension system on risky assets returns, the booming 1990s made New Jersey's plans looked overfunded. A combination of fictitious accounting and high-octane market performance made the plan look cheap and led the legislature to grant a sudden 9 percent benefit enhancement in 2001. That sweetener added a reported $3.1 billion to the system's liability (though when properly valued, it's closer to $7 billion) and it's still in place for workers hired before 2011. The state proceeded to underfund the system for several years.
So in spite of recent reforms, state and local pension systems must still contribute larger amounts to guarantee earned pension benefits for their workers. The problem is decades in the making and driven by several forces: flawed accounting standards which lead to weakened pension plans, the short-term outlook of elected officials, and the refusal of unions in the collective bargaining process to deal with budgetary reality.
What unions fail to acknowledge is their proposals will drive their employers (state and local governments) to fiscal ruin. Instead, they should seek an outcome that balances the interests of both workers and those who pay the bill—the taxpayer. Far more will need to be done, but it will not happen until governments remove the rose-colored glasses and accurately account for the liabilities on their books.
Correct 06/12/2012: A previous version of this post misidentified the gap in the Wisconsin budget. It was $3.6 billion.