Public Employee Union Benefits Are a Fiscal Disaster

The coming crisis could lead to a bond market panic.


State governments are in a huge hole, and they're still digging. Thanks to the Great Recession, their tax receipts have suffered the greatest decline since the Great Depression: now 12 percent below pre-recession levels (adjusted for inflation). For their 2012 budgets, states face gaps hovering around $140 billion, and that's on top of previous budget shortfalls of over $400 billion since the recession began.

Federal assistance had mitigated previous-year deficits, but there is now only about $40 billion left in the program. High unemployment will keep state income tax receipts below normal levels. President Obama's healthcare bill has compounded the fiscal effects of Medicaid expansion on states. Medicaid costs from 1998 to 2008 had already risen four times as fast as the consumer price index, but the new impositions are eating up state budgets as additional support for Medicaid from the federal government will expire in June 2011. Add to this red ink the drop in revenue from the big investment losses experienced by state pension funds.

Some 30 states face a structural budget gap, where ongoing expenses are not covered by revenues. California, for instance, projects a structural budget gap of over $20 billion in fiscal 2012, $22.4 billion in 2013, and $20.4 billion in 2014. New York's projected gap is $9 billion in 2012, $14.6 billion in 2013, and $17.2 billion in 2014.

States have shied away from making unpopular cuts in core services and state workforces beyond what they have already done. They sowed the dragon seeds in the fat years by buying off service unions with generous pensions, employee contracts, healthcare, pay, and benefits. According to a study by Daniel DiSalvo, a political scientist at City College in New York, state and local workers now earn an average of $14 more per hour in wages and benefits than their private sector counterparts. In general, the average state government worker reaps retirement benefits several times richer than a counterpart in the private sector, a critical reason why public pension costs have become unsustainable. For example, state and local governments contributed $3.04 per hour toward each employee's retirement in 2007, according to U.S. Labor Department figures, while private employers paid 92 cents an hour.

Public and private sector workers live in separate economies. The public sector unions are flourishing. The private sector has had to let go many of its workers as economic conditions have worsened. They suffer through frequent turnovers, relentless downsizing, stagnant wages, and rising health insurance premiums. They often fund their own retirements through 401(k)'s and similar plans, which rise and fall with the tides of the economy. By contrast, the public sector is a haven of security and stability, where people have jobs for life and performance measurements are rare. Most public sector workers enjoy job security and boast defined benefit retirement programs. The number of government jobs rose even as overall unemployment in this recession jumped past 10 percent.

States may not declare bankruptcy and cannot be sued by creditors. Nor can they be forced to behave by a higher level of government­—and the federal government is broke anyway. Yes, all states, except for Vermont, require annual operating budgets to be balanced. But the definitions of what constitutes revenue is vague enough that it is still possible for states to rack up debts by hiding the gaps through one-shots like asset sales and borrowing.

The most egregious issue is pensions. Many state workers can retire in their mid-50s on close to full pay and, therefore, can receive pensions for more years than they have worked, even though they are young enough to take another job. In this sense, public sector pensions have created a new class of millionaires. Take a pension's present value; that is how much cash you would need to buy an annuity making payments equal to the pension. In many cases, you would find the cash needed would be well into seven figures. And these calculations don't even include the value of retiree healthcare benefits, which for many retirees vastly exceed those in the private sector. In a number of states, these benefits include health insurance approximating $14,000 per year for family coverage, which is exempt from taxation.