I read an article this week about the state of the fiscal condition of Connecticut. They are teetering on bankruptcy and they are not unlike many other states. Fiscal responsibility at the state level seems to be something they can ignore. When the end comes they will demand that the federal government (read that taxpayers) bail them out for their folly.
One of the major culprits in the financial crisis so many states are finding themselves if are the overly generous pension benefits they have awarded employees of state government.
Lets take a look again at Connecticut. Health insurance for state employee has no deductible. Pensions are based on earnings, not salary, and the result is that as they near retirement state workers find ways to work as many overtime hours as possible, thus inflating their earnings and ultimately their pensions. This creates a large unfunded mandate on the state and makes it difficult to keep revenue-matching costs in the future.
So how as Connecticut looked to solve these problems and how is their revenue generated. In the past Connecticut has relied on having a high number of wealthy people. Serving as a commuter point for people working in New York this has increased the number of high earning workers and the number of independently wealthy people. Their state income tax rates reach as high as 7% on income and the middle class in Connecticut see their income taxed at around 6%.
The problem is becoming acute because people eventually tire of paying higher taxes and so they move. Connecticut is seeing a significant number of high income people fleeing the state. Businesses are leaving as well.
If you think those rates are high, take a look at California. They have nine brackets and a middle class couple making about $150,000 (it sounds high but not in California) would find themselves in the 9% bracket. And if you think all that taxation would keep the state flush with cash you would wrong. The Governor is now predicting a budget deficit of $1.6B. That is large but nowhere near the $20B deficit they had a few years ago. But they are masking the real problem that they will face. In 2003 the state had an unfunded public pension liability of $6.3B. Ten years later that figure had risen to $241B. That is correct, they have an unfunded pension liability that is over $240B and growing each year. And that does not calculate in the unfunded liability of health costs for state retirees. Some experts now estimate that number to be $150B and growing.
Other states are in the same boat. Politically they are unable to cut the benefits to state employees. The labor unions for these workers support the liberal politicians in office with both campaign contributions and with voter turn out initiatives. They have been rewarded with higher and higher pension and health care benefits.
In 1986 the Federal Government realized that the pension system it was operating on was not sustainable long term. At that time it was the Civil Service Retirement System (CSRS). Under that system you contributed about 6% of you wages into the system and you were rewarded with a pension that gave you 2.5% back for every year you worked and it was based on your high three. As an example if you went to work for the federal government just out of school and worked for 30 years you could retire in your early to mid fifties at 75% of your high three salary. Most workers retired and simply took another job.
The change to the Federal Employee Retirement System redid all the calculations. Under the new system you paid in significantly less than before and your benefits would also be less. Now you earn 1.1% for retirement for the first twenty years of service and 1% for years after that. The same retiree would work 30 years and be able to get 32% of their high three. To supplement this reduction the government began offering a version of a 401(k) with the Thrift Savings Plan. You can contribute as much as you want up to the limits and the agency you work for makes a small matching contribution. Simply put, this starts to match retirement plans in the private sector. Still a little more generous than most private plans but certainly an improvement.
So what can the states do to solve this fiscal problem? First, they have to take a hard look at what their pension systems look like compared to the private sector. If it is too generous they need to develop a replacement that is more in line with today’s pension benefit programs and one that is not going to strangle them with increasing debt. Second, they need to man up and divorce themselves from the politics of making such a change. Will liberals find that the employee unions are irate that they might alter their benefits? Yes. But they have to then decide if they are pawns to those employee unions or working for the overall fiscal health of the state and the citizens of the state. These are two very difficult issues for liberal Democrats but if they don’t make these tough decisions they will come begging to the taxpayers of the country to bail them out and the answer to that should be a resounding NO.