Wishful thinking isn’t a budget strategy

Bob Williams President, State Budget Solutions
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When it comes to state budgets, wishful thinking is about the worst thing government officials can engage in. A case in point: Illinois.

In 2011, Illinois’ state pension systems used an average expected return of more than eight percent to value their funds — a patently unachievable return by any rational standard — which to no one’s surprise resulted in a funding shortfall of $83 billion. When Moody’s Investors Service used the more realistic assumption of 5.67 percent, reflecting the market rates existing at the time of the funds’ 2011 valuation, the state’s net pension liability jumped to 238 percent of state revenues.

Why are these differences so important? Because when you deal with budget facts rather than budget wishes, and do so as soon as possible, you can plan accordingly and, in the long run, save taxpayers a bundle by making appropriate investments or cuts to what the state funds. Unfortunately for anyone who pays taxes in Illinois, leaders in the House and Senate are typically the last to realize (or at least the last to admit) just how bad the situation is. Official state reports list a funding shortfall of $100 billion, but that is nowhere near the truth, as the state relies on ridiculously high investment return assumptions.

When Moody’s applied realistic assumptions to the same numbers, it found that the State of Illinois faced unfunded liabilities of $135 billion. This assessment played a part in reducing the state’s credit rating this past month. That means that when the State of Illinois has to borrow, it must pay more than it should if its fiscal house were in order, and it isn’t government officials themselves who pay more — it is taxpayers. By the time a 2012 valuation is conducted, the unfunded liability as understood by Moody’s will approach $200 billion. These estimates fall in line with the results from a 2010 study by economist Andrew Biggs, who found that the market value of Illinois’ unfunded liabilities was more than $192 billion.

The state has repeatedly failed to address the crisis and, as a result, is now slipping into a financial abyss. Special sessions have produced nothing special, and certainly nothing resembling a solution. Most recently, the governor halted legislator salaries until they address the pension problem. House Speaker Michael Madigan and Senate President John Cullerton — instead of focusing on the pension problem dragging down the Land of Lincoln — opted to sue the governor over his attempt to spur action.

No wonder Moody’s has already downgraded Illinois five times in the past four years, making Illinois’ credit worthiness among the worst in the nation. Other ratings agencies, including both Fitch and Standard & Poor’s, have likewise downgraded the state’s credit rating a combined total of eight times in that same period.

Legislators in Illinois at some point must show some sense of urgency instead of exacerbating the status quo. Recent proposals considered by lawmakers demonstrate perfectly how woefully inadequate they are when it comes to providing real solutions for the state’s looming financial crisis. In the most recent session, lawmakers floated the disastrous idea of a “funding guarantee” that effectively would prioritize funding state-paid pensions before funding all other state services, including emergency services.

So what’s the solution for Illinois? First, to stop growing liabilities, new workers can no longer be promised the lavish pensions previous government employees were awarded. New state workers need to be placed into a defined contribution system in which the amount of the employer’s annual contribution is specified. In this system, investment risks and rewards are assumed by each employee rather than the state. When legally permissible, this should also be applied to current employees.

A well-designed defined contribution system will not leave taxpayers on the hook for unknown billions in employee retirement benefits. The system provides stability and certainty in the annual budget process, as contributions would be a simple percentage of payrolls. Increased portability would appeal to a workforce that values greater employment portability.

Any changes to the status quo will undoubtedly stir controversy and face legal challenges. Nonetheless, continued inaction and squandered opportunities must not be the outcome of the special session, or it will only bring the state closer to drastically diminished, impaired or, one day, nonexistent retirement benefits.

Bob Williams is President of State Budget Solutions, a non-partisan organization advocating for fundamental reform and real solutions to the state budget crises.