Is Illinois Wimpy?

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on Dec 13, 2010

When one thinks of Illinois past and present, “wimp” is not usually the term that comes to mind.  Whether one is remembering the famous gangsters of the 1920s and 1930s, the rough-and-tumble machine politics that spanned most of the 20th century, or the long history of great athletes (e.g., Michael Jordan) and sports teams (Bears, Bulls, and our very own Illini), “wimpy” is not the first term to come to mind.

But I have a specific “Wimpy” in mind.  Who can ever forget the character “J. Wellington Wimpy” – better known simply as “Wimpy” – from the cartoon series Popeye? Wimpy’s most famous line, “I will gladly pay you Tuesday for a hamburger today,” is all-too-apt for Illinois’ fiscal situation. Indeed, a Wikipedia entry on Wimpy describes him more fully as “very intelligent, and well educated, but also cowardly, lazy … and utterly gluttonous.”  Sounds a lot like a collective description of our Illinois state government.

This view was reinforced this week when I read a Wall Street Journal story “Illinois seeks Wall Street Cash.” As anyone who has paid even a moment’s attention knows, Illinois’ fiscal situation is dire.  We have inherited enormous fiscal obligations from prior generations of Illinois politicians and citizens that did not pay their own way, and the current generation of so-called “leaders” seem content (at least in actions, if not in words) to not only pass these burdens along, but to add to them.

Often, it is difficult to get citizens to focus on federal or state fiscal problems because they seem to remote – either far off into the future, or affecting us only indirectly.  What is quite interesting about the WSJ article is just how clear and immediate Illinois’ fiscal problems have become.  As reported by the WSJ, “The state owes more than $4.5 billion to vendors large and small, ranging from prison-cleaning crews to schools for the disabled.”  Those of us at the University of Illinois have certainly witnessed this first-hand, as the state has been consistently late in providing the cash to back-up the appropriations that is has supposedly dedicated to the University.

To the state’s credit, it is looking for ways to take some of this burden off of the vendors.  In essence, they want to find investors who will pony up the cash in the short-run, in return for gaining claim to the 1% per month late fees.  There may be some takers – after all, in this low-interest rate environment, a 12% return on investment sounds pretty good, even recognizing the inherent risk that the state does not seem to have a plan for making good on its longer term commitments.

Of course, this is a quick-fix.  A band-aid.  It is borrowing from Peter to pay Paul. It takes the financial pressure off of vendors, which is clearly good for them.  But the danger is that it might also take the pressure off the politicians to really fix the problem.

I am all for paying our bills.  But we need to truly pay our bills, not just change the name on the i.o.u.’s.

Using Pension Obligation Bonds to Feed our Spending Addiction

Filed Under (Retirement Policy) by Jeffrey Brown on Jul 20, 2010

Several recent news reports have indicated that Illinois is planning on selling pension obligation bonds in order to come up with the cash to make its contributions to the five state public retirement systems for the next fiscal year.  This is by no means the first time that the state has used POBs: In 2009 it issued just under $3.5 billion of bonds to fund its pension contributions for 2010.  Back in 2003, it issued about $10 billion in bonds for the same purpose.

So, are issuing such bonds a good idea or not?  The answer depends on who you are, and what you are trying to achieve.

If you are a participant in one of the five public plans, the issuance of these bonds sure beats another year of having the state fail to make its contributions.  While I have written before that public employees have little to worry about given the nature of the constitution benefit protections that are in place, any lingering concerns about the state’s inability to make good on pension promises ought to be at least partially mitigated by having additional contributions made into the pension funds.  This is true regardless of whether the funds came from higher taxes, reduced spending, or borrowed funds.

If you are a politician, this is really a good plan because it allows you to – once again – avoid behaving like a responsible adult and making the difficult fiscal choices that ultimately need to be made.

If you are a current taxpayer, it also looks pretty good.  First, we avoid raising taxes now.  Second, we are essentially converting implicit debt (money owed to pensioners) into explicit debt (money owed to bondholders), with the key difference being that it is actually somewhat easier to default on the explicit debt than it is to violate the constitutional non-impairment clause (this is precisely the opposite for Social Security, in which it is easier to reduce benefits than to default on U.S. government debt). 

If you are a beneficiary of other government spending programs, you are also pretty happy.  After all, borrowing to fund the pensions puts less pressure on politicians to cut your favorite spending program.

So far, so good.  Sounds like everyone is a winner.  So, what is the catch? 

The catch is that issuing these bonds takes the pressure off of our elected officials to exert fiscal discipline.  It is like trying to cure a spend-a-holics debt problem by giving them a credit card.    

As such, the losers are all the future generations of taxpayers and program beneficiaries who are going to be saddled with several additional billion dollars worth of debt that must be serviced because we gave today’s politicians an “easy out” from facing their responsibilities today.  This reduction in fiscal discipline is made all-the-more dangerous when these bonds are portrayed as a way to magically reduce our obligations by more than the amount of the debt issuance.  All too often, one hears proponents of these bonds make statements about how the state can borrow at a low rate and invest at a high rate, and thus make money on the difference.  Invariably, such statements ignore the risk differences in the investments, and are akin to try to create a free lunch where none exists. 

Thus, the biggest downside to the use of these bonds is that they are an “enabler” for politicians who are addicted to deficit spending.  The direct effect of this resulting debt burden will be to increase the pressure to raise future taxes and cut future spending on education, health care, roads, state police and every other spending program that people may value.

The indirect effect is that higher future taxes will turn Illinois into an unattractive place for businesses to invest or for our most talented young people to build careers, homes and families.  Who wants to invest in a state that is saddling future generations of businesses and workers with debt?

Misguided Reform Rhetoric Around Illinois Pensions

Filed Under (Retirement Policy) by Jeffrey Brown on Mar 31, 2010

Illinois pensions are in the news yet again.  Last month, the Pew Center on the States reported that Illinois was once again the poster child for everything wrong with the funding of state pensions, noting that we had the worst funding ratio of any state in the country.

 

Last week, Illinois House Speaker Michael Madigan decided – finally – to take some action.  He secured a House vote to change pension benefits for future Illinois state workers.  Specifically, this proposal would raise the full benefit age to 67, cap the maximum pension income at a bit over $100,000, limit cost-of-living increases, and so on.  In short, the package amounts to benefit reductions for not-yet-hired future state workers.  

 

Why this option?  To put it simply, there are only two options for fixing the funding problem. 

 

Option one is increase revenue to the system.  In other words, make additional contributions.  But this would require that Illinois lawmakers raise taxes or cut other state spending, neither of which is politically popular.  

 

Option two is to reduce the liabilities.  But as I have written before, the impairment clause in the state constitution prohibits benefit reductions to existing retirees and existing employees.  So the only way to reduce liabilities is to cut benefits for future workers – those that have not yet joined the system.  And that is precisely what Madigan pushed through the House.

 

[By the way, the only “option three” is to, in the words of Alan Greenspan when discussing Social Security, is to “repeal the laws of arithmetic.”  I am pretty sure that most state governments would choose this option if they could!]    

 

As a fiscal conservative, I have no real objection to the decision to reduce future liabilities in the way that the House has chosen to do.  But two issues that have come up in the debate that I think are worth a bit of analytical clarity.  

 

First, estimates of future savings are almost surely inflated.  There are two reasons for this.  One is that some of the estimates appear to have simply looked at undiscounted dollar flows, which implicitly assumes a dollar saved in 2050 is the same as a dollar saved in 2020.  This is obviously not the case, since a dollar saved earlier has a much higher present value.  A second reasons is that – as I have written before – pensions are part of the overall compensation package.  If we reduce future retirement benefits, our ability to attract top faculty members, for example, will be reduced unless we increase compensation in some other way.  None of the cost savings estimates account for this.    

 

Second, there is clear confusion about the source of the funding problem.  Much of the rhetoric around this legislation focused on the level of benefits.  The Champaign News-Gazette is a typical example, stating:

“A big part of Illinois’ horrendous budget problems can be traced to the high costs for the lavish pensions many public employees enjoy. They are far more generous than those available to workers in the private sector, and that’s a big reason why state public pensions are underfunded to the tune of an estimated $80 billion.”

This is wrong for several reasons.

First, the real source of the funding problem is not level of benefits.  It is the fact the Illinois legislature has consistently failed to make the annual contributions that are called for under standard funding formulas.  My colleague Fred Giertz has done some calculations suggesting that if the legislature had made its required contributions every year, the Illinois system would be slightly over-funded, not under-funded.  In short, don’t blame the pensioners for the lack of fiscal discipline on the part of our politicians.

Second, the comparison of public pensions to private pensions is misleading.  One reason is that the public pension replaces both Social Security and a private pension.  Social Security costs roughly 12% of payroll today.  Private employers who offer pensions typically contribute several percent more.  On that basis, Illinois public pensions are not “lavish.”  A second reason is that – yes, I am repeating myself – this is part of an overall compensation package.  So any comparison needs to account for the value of all salary and benefits, not just a single piece of it.