First, understand the cause of it all; then re-amortize the debt
By RALPH M. MARTIRE
This is a column about fixing the state’s pension funding problems. However, a problem really can’t be solved unless the proposed solution addresses its true cause.
So, what caused the growth in the state’s unfunded pension liability from $17 billion in 1994 to $132.5 billion today? As it turns out, three factors are to blame.
First, there are items inherent to the design of the pension systems themselves, like benefit levels, salaries and actuarial assumptions. The state’s own data, however, show that benefits and salary levels had a very immaterial impact — roughly $2 billion — on the growth in the unfunded liability over that period. The state did recently lower the anticipated rate of return used in its actuarial assumptions — which will contribute significantly to increasing the unfunded liability going forward, but wasn’t the main driver of the current hole.
Second, there’s the $15 billion in assets lost during The Great Recession, which hurt, but wasn’t the killer. The vast majority of the growth in unfunded liability is made up of the third contributing factor: DEBT. Indeed, for decades the state has used the pension systems like a credit card, borrowing against what it owed them to cover the cost of providing current services, effectively allowing taxpayers to consume public services without having to pay the full cost thereof in taxes.
The reason for all this borrowing from the pensions is Illinois’ longstanding structural deficit. A “structural deficit” exists when state taxes fail to generate enough revenue to continue funding the same level of public services from one fiscal year to the next, adjusting solely for changes in inflation and population.
For decades, state elected officials chose to paper over — without resolving — Illinois’ structural deficit by borrowing against what they owed the pension systems and using that borrowed revenue to fund public services. Hence the state pension systems — against their will — were lending money to the Illinois General Fund to subsidize the cost of delivering current services.
By FY1994, Illinois lawmakers had borrowed so much against the pension systems to pay for services that there was a cumulative unfunded liability of $17 billion, or double what it was five years previously. The funded ratio was just 54.5 percent, which was problematic, given the Congressional Budget Office says a public pension system should be at least 80 percent funded. Ostensibly to rectify this situation, in FY1995 the General Assembly passed and Gov. Edgar signed P.A. 88-0593, establishing the “Pension Ramp.” The Pension Ramp mandated that the state’s annual pension contributions be made pursuant to a defined repayment schedule that’d get the systems 90 percent funded by 2045.
Although the publicly stated rationale for the Pension Ramp was to repay debt owed to the pension systems, it also served another, unpublicized purpose. See, by law, the Pension Ramp continued the practice of borrowing against the full contributions owed to the pension systems to subsidize the cost of delivering public services for 15 years after passage, contributing to another $45 billion in debt — not including interest. P.A. 88-0593 accomplished this boondoggle by creating a repayment schedule that was ridiculously back-loaded.
The back-loading was so significant that it called for pension payments to grow annually at rates that were simply unattainable. Consider that in FY2009, the last year before the back-loading really kicked in, the state was required to make a $1.6 billion payment to the pension systems. In FY2018 the Pension Ramp called for a $7.1 billion payment. That’s a whopping jump of $5.5 billion or 344 percent. For context, inflation only grew by 17 percent over that same sequence.
To date, most attempts to resolve the unfunded liability have focused on cutting benefits. This approach is doomed to fail for two simple reasons. First, the Illinois Constitution expressly provides that retirement benefits for public workers cannot be “diminished or impaired.” Illinois Supreme Court decisions have consistently ruled that this constitutional prohibition on “diminishing or impairing” benefits means precisely what it says. Bottom line: attempts to cut existing benefits are unconstitutional.
Second, as indicated previously, benefits are neither the main driver of the growth in unfunded liability, nor what has created the significant pressure on the state’s fiscal system. Debt is the primary driver — and the unrealistic repayment plan under the Pension Ramp, is what’s stressing the
Hence, the only viable option is to re-amortize the repayment schedule created under the Pension Ramp in a manner that: increases the funded ratios of the five systems annually to the point that they become healthy; accomplishes that growth in funded ratio after accounting for all cash flow obligations to pay benefits to current and future retirees; and is affordable, given the other demands on current tax revenue to fund core services. A reamortization that smooths pension payment obligations out into annual increments that are level, akin to a traditional, fixed-rate mortgage, does the trick. In fact, in the long-term, using a level dollar approach becomes fiscally advantageous, because in real, inflation-adjusted dollars, the annual contribution actually declines from year-to-year. After running the numbers, a level dollar repayment of approximately $11.1 billion per year — which is more than the current payment under the Pension Ramp — but significantly less than future payments works.
By “works,” I mean gets Illinois’ five pension systems approximately 80 percent funded by FY2045, putting them on a sustainable path toward fiscal health. Better yet, contributions over the FY2018 to FY2045 sequence would be some $65.6 billion less than what the contributions would be during that time under the current Pension Ramp. In other words, a real solution that is both constitutional and addresses the true driver of the problem.
Ralph Martire is executive director of the Illinois-based Center for Tax and Budget Accountability, a bipartisan fiscal policy think tank. He can be reached at [email protected]