By: Mark Glennon*

Why worry about unusually large unfunded pension liabilities? Why not let them run, or maybe even let them grow until the pensions become simple pay-as-you-go systems? Some pension reform opponents say that’s the best approach. In truth, with ever-growing unfunded pension liabilities, that’s effectively the path Illinois and some other states have been on.

The answer is that the enormous cost renders those states permanently uncompetitive. Every state seeks to maintain levels of services and tax burden that are at least competitive with other states. Exceptionally large legacy pension debt, however, makes that impossible. Services suffer and taxes increase, as they have in Illinois, because of out-sized pension costs.

Most importantly, the disparity between the least funded and best funded states accelerates. Illinois and the other worst-off states are becoming less and less able to maintain competitive levels of service and taxation compared to more responsible states.

New data from Pew Charitable Trust illustrate that result.

Their report released last week shows that the gap between well-funded public pension systems and those that are fiscally strained has never been greater. To illustrate, Pew focused on the best three states and the worst three. South Dakota, Tennessee, and Wisconsin had, on average, 97 percent of the assets needed to fully fund their pension liabilities in 2007 and remained at 95 percent funded or higher in 2017. Conversely, the three states with the lowest funded ratios—Illinois, Kentucky, and New Jersey—saw a drop from 69 percent funded, on average, in 2007, to 36 percent funded in 2017.

The same pattern applies to other states. According to Pew:

Across the country, we see this same pattern of disparity…. And although all states suffered declines in reported funded status over the five years between 2007 and 2012, states that were at least 90 percent funded by 2017 had seen their funding levels increase in the years following 2012. On the other hand, states that were less than two-thirds funded in 2017 reported further declines in financial position from 2013 to 2017 despite strong investment performance over that period.

The result? The better-off states feel little pressure on their budgets and the worse-off states have enormous portions of their budgets gobbled up by pension costs. Those three healthy states – South Dakota, Tennessee and Wisconsin – face true, total costs for pensions, pensioner healthcare and bonded debt** of less than 7% of their budget towards pensions and pensioner healthcare. But Illinois, Kentucky and New Jersey face costs of 50%, 27% and 37%, respectively.

Or look at unfunded liabilities as a percentage of personal income, also provided by Pew. For the country as a whole, unfunded  pension and pensioner healthcare debt represents 11.1% of personal income. For those three best-off states, it’s under 2%. But in Illinois, Kentucky and new Jersey those costs represent 26%, 18% and 23% of personal income.

The disparity is worsening for several reasons. Pensions as badly unfunded as Illinois’ cost three or four times as much to service annually as properly funded pensions because they don’t have assets invested, returns from which funds the bulk of the cost for healthy funds. A healthy stock market like we’ve had since the Great Recession doesn’t help much if the assets simply aren’t there. Finally, at least in Illinois, we don’t even pay interest effectively accruing. The hole deepens every year just like a negative amortization mortgage, even though a quarter of our budget goes to pensions alone.

In short, the most underfunded states are tied to a ball-and-chain, consuming their budgets and overburdening their citizens. States that have addressed their pension problems properly are free to improve service, cut taxes or both.

And the gap is growing.

*Mark Glennon is founder of Wirepoints.

**See our report on this analysis prepared by Michael Cembalest at J.P. Morgan Asset Management linked here. Service on bonded debt is a small part of the total.

For further background on Illinois’ pension crisis:

With Pension Advice Like This, Chicago and Illinois Are Doomed  July 2, 2019

Rank Dishonesty on Pensions From AFSCME’s Executive Director June 23, 2019

Rhode Island Supreme Court Shows Illinois The Way On Pension Reform June 12, 2019

Why Warren Buffett is right to warn about Illinois: The state’s true retirement costs now total 50% of annual budget May 6, 2019

Illinois Democrats’ Astounding Reversal On Pensions February 3, 2019

Illinois pensions sink during record bull market run August 23, 2018

Overpromising has crippled public pensions: A 50-state survey  February 12, 2018

Incomes in top 50 Illinois cities can’t keep pace with state pensions February 12, 2018