By: Mark Glennon*
The Stanford Institute for Economic Policy Research recently published a splendid new database, Pension Tracker, that includes “market based” numbers on state and local pension debt. For Illinois, the numbers (linked here) are simply astounding.
Pensions, governments and reporters use “actuarial based” numbers, which are built on assumptions typically set by politically appointed pension trustees. Those assumptions include, most importantly, high earnings expectations for pension investments — the “discount rate” — typically, about 7.5% — which no reputable financial economist accepts. Pension Tracker shows those numbers and also “market based” numbers, for which it uses twenty-year Treasury yields as the discount rate.
The logic there is that, since pensions are guarantied, the underlying assets to pay them likewise should be guarantied, and that means United States Treasury bond rates. Twenty-year Treasury yield ranged from 2.50% to 4.25% between 2008 and 2014. To put it another way, if you went out to buy an annuity matching a pension with a no-risk guaranty, it would be very expensive because it have to be based on low Treasury yields.
For Illinois, the commonly reported actuarial debt (the unfunded liability) for state and local pensions totals $140 billion, or about $29,000 per household.
But the market based pension debt (the unfunded portions) for those pensions is a stupefying $371 billion, or $77,822 per household, according to Pension Tracker.
Instead of the commonly reported funded ratio of 45% using actuarial numbers, the market based funded ratio is just 23%.
Think about those per-household numbers in practical terms of who really pays taxes, and this goes beyond ridiculous. Even in flat tax Illinois, taxpayers with incomes over $100,000 per year –the top 18 percent of Illinoisans — pay 63 percent of all income taxes. If that same relative burden held, each household with an income over $100,000 would be responsible for about $432,000 of pension debt.
Or, suppose we accept the reasoning behind the recent graduated income tax proposal, which is that taxes should be cut for 99% and raised just on the top 1%. That would mean the top 1% would bear an obligation of over $7.8 million each.
Even if you use the officially reported actuarial numbers, the burden for high earners is still staggering. The top 1% would be liable for about $1 million each if you stuck only them with the liability. If you spread the liability as our current tax structure does, the top 18% who earn over $100,000 would be liable for $163,000 each.
Yet, pension reform opponents continue to claim there’s no reason to fear that pension obligations can contribute to out-migration.
Good arguments can be made that Stanford’s 20-year Treasury rate is too low for most pensions, unfairly increasing the liability. However, given that many Illinois pensions are bleeding out towards zero well before 20 years (including all Chicago’s pensions), and that Illinois courts say pensions are guarantied hell-or-highwater, Stanford’s approach is quite defensible for Illinois.
And the raw Stanford numbers are understated, for several reasons. First, they worked off of FY 2014 data and our pensions have deteriorated since then. Second, they don’t include healthcare liabilities for pensioners, which are now constitutionally guarantied along with pensions. Healthcare adds more than $50 billion just to the state pension liability, and who-knows-how-much for local pensions (because nobody tabulates that total reliably). Finally, that $50 billion dollar healthcare liability is badly understated because it’s discounted, too, even though there are zero assets set aside to pay it, which makes little sense.
Big salute to the Stanford Institute for Economic Policy Research for their work. Shame on Illinois universities for being AWOL on this and other aspects of our pension apocalypse.
We’ve said it before and we will keep saying it: This is insane. Pure madness.
*Mark Glennon is founder of WirePoints. Opinions expressed are his own.