Uncle Sam can't bail out states if he's broke

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Large federal budget deficit numbers are becoming routine. President Obama's new budget confirms a deficit of more than $1 trillion for fiscal 2012, the fourth year in a row with a deficit of that magnitude.

But $4.4 trillion? That's the state and local pension and health care underfunding presented in a new Senate Finance Committee Republican staff report, equal to about four years of federal deficits.

The report, "State and Local Government Defined Benefit Pension Plans: The Pension Debt Crisis that Threatens America," shows that the unfunded liabilities of state and local governments are rising rapidly, up from $3 trillion in 2009.

According to Sen. Orrin Hatch of Utah, the ranking minority member of the committee, "the public pension crisis plaguing our nation demands a real solution." Over the next few weeks he plans to bring forward a series of proposals to reform these public plans.

Such pensions will have to be paid over time to the 19 million men and women who work for state, county, school district, and municipal governments.

The Hatch report warns that, if pension fund income is insufficient to cover obligations, they will have to be paid by taxpayers, either of the respective states or by all of us, if Congress decides to ride to the rescue.

For many years, a growing economy propelled increases in stock prices, enhancing the coverage of many pension plans, public and private. But stocks have not fully recovered from the market's collapse in 2007-2008.

An increase in unfunded liabilities could not have come at a worse time for state and local governments. Many states face record operating deficits from the recession and are looking at a potential expansion of Medicaid obligations if Obamacare is fully implemented in 2014.

And, to balance their budgets, they have been laying off employees, thereby shrinking the number of people paying into their respective pension funds. What to do?

Although private plans can reduce employee benefits and increase contributions to bring underfunded plans into financial health, many public sector plans have been prohibited by the courts from doing this.

New employees can be charged a higher contribution rate for lower benefits, but not current employees who were hired under more favorable terms. One option is to gradually raise the retirement age for new employees. In many states, employees can retire at age 50 and start collecting benefits.

States could allow workers to retire at the same age but postpone the age at which workers begin to collect benefits. That would cause some employees to keep working, adding to their eventual retirement benefit.

States could also convert pension plans to defined-contribution plans, such as 401(k) plans in the private sector, which have been gradually displacing corporate defined-benefit pensions.

Plans can be closed to new entrants, while retaining existing employees. Or plans could be closed to new employees, while transferring current workers to defined-contribution plans. In either case, the state remains responsible for liabilities of present retirees and future benefits owed to current workers.

Some analysts think that the problems are so severe that the federal government will end up bailing out the states. That's one reason, according to Standard and Poor's, it downgraded U.S. government debt in August 2011.

The feds will be tempted to help because about 5 million state and local government workers are not covered by Social Security. If their pension plan goes bust, they would have nothing except their own savings.

But Obama's budget shows that Uncle Sam is making no progress in paying his own bills, and is in no position to bail out the states. They need to act soon.

Examiner Columnist Diana Furchtgott-Roth (dfr@manhattan-institute.org), former chief economist at the U.S. Department of Labor, is a senior fellow at the Manhattan Institute for Policy Research.

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Diana Furchtgott-Roth

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The Washington Examiner