Public sector pensions and other post-employment benefits (OPEB) such as health insurance are becoming a severe drag on an increasing number of state budgets. California’s state and local pension debt is somewhere between $300 billion and $1 trillion depending on earnings assumptions, and with tax rates that are already some of the highest in the country it’s not clear how the debt will be covered. Illinois, New Jersey, and Connecticut are just a few of the other states with notable pension problems. In fact, unfunded pension liabilities are probably the biggest fiscal problem facing state governments today.
In a new Mercatus Center study that ranks each of the 50 states and Puerto Rico according to their fiscal condition, one common theme among the worst performing states is their drastically under-funded public pension systems. According to the study, all of the bottom five states – Connecticut, Massachusetts, New Jersey, Illinois, and Kentucky – are below average in trust fund solvency, which measures a state’s risk-adjusted pension obligations. Kentucky and Illinois rank especially poorly at 45th and 46th respectively.
The study notes that all of these states have attempted pension reform but have yet to enact anything substantial. Meanwhile, their unfunded pension liabilities continue to grow. This means that future reforms will likely require even larger tax increases or deeper cuts in benefits or other government services in order to fully fund promised pensions and OPEB.
In addition to their pension woes, demographics don’t favor these states. Americans have been moving to warmer climates for the last several decades, a trend that doesn’t bode well for colder states like Illinois and Connecticut that are already struggling to fund their pensions. From 2010 to 2015 the aforementioned bottom five states grew less than the U.S. average of 4.1%. Illinois and Connecticut experienced particularly slow growth of less than 1% over that five year span.
If unfunded pension liabilities grow faster than the population the financial burden per taxpayer increases over time. The threat of higher taxes to make up for slower population growth may induce more people to leave the state. The result could be a long-lasting cycle of population decline. This is bad news for Connecticut, Illinois, and New Jersey, as all three states already had per capita unfunded liabilities of around $20,000 in 2012, nearly $7,000 higher than the U.S. average.
Currently the difference between Connecticut’s $21,378 per capita liability and Tennessee’s $5,676 liability is only on paper, but if taxes are raised in each state to close their pension gaps there is nothing to stop Connecticut’s most mobile taxpayers from moving to a fiscally better state like Tennessee, Florida or North Carolina. Not only would they escape higher taxes, but relatively bad winters as well. For many people that’s a win-win.
While unfunded pensions and OPEB is not the only fiscal problem facing state governments it is a significant one that affects every state to some degree. Other issues highlighted in the Mercatus Center study such as a recurring budget deficit, insufficient assets on hand relative to long-term liabilities, and a weak cash position that can make it hard to cope with a recession are also notable problems that voters should be aware of. But while these short-term problems also need solutions, eventually voters and state officials must do something about their unfunded pension liabilities if they want a prosperous future for their state.
