There is a dirty secret about state entitlements that liberals don't want you to know: The collection of a state pension increases the chances that a pensioner will live in poverty. That's because money put aside for state-guaranteed benefits cannot be safely invested at rates that provide for more than a modest retirement unless the state subsidizes retirement benefits through taxes or if retirement savings are invested in riskier, higher yielding investments. Since governments are loath to raise taxes to subsidize a risk-less retirement, benefits are eventually reduced. It works that way in London and Moscow as well as Madison and Sacramento.
In Moscow, public pensions and social programs helped bankrupt the Soviet Union in the 1980s while "transfer to pension status greatly increase[d] the likelihood of poverty," according to Mervyn Matthews' 1986 book "Poverty in the Soviet Union." In London, former Labour Minister John Hutton's Independent Public Services Pension Commission has recommended changes that would calculate pension benefits on lifetime earnings rather than current salary -- in line with recommendations for pension reform from the Organization for Economic Co-operation and Development (OECD). Trade unions in the United Kingdom say that such changes will lead to "increased pensioner poverty." In Madison, Wis., public retirement applications have risen 73 percent, according to the Wall Street Journal, as workers try to lock in higher retirement benefits that will likely shrink for those public employees retiring in the future.
Increasingly, state governments in the United States are facing budget shortfalls over entitlements paid to public servants and those on the public dole. And like the Social Security program, the shortfalls have been wholly predictable as government makes bigger and bigger promises to a select number of citizens who then take up a bigger share of the public pie.
As Rep. Paul Ryan, R-Wis., has been warning: Entitlements could bury this country if we don't address them soon.
In a powerful and harrowing piece -- "Rates of Ruin" -- for the May issue of Townhall Magazine, Finance Editor John Ransom explains the dire consequences of politicians' pension promises if they remain unchanged.
Behind the rhetoric and the rants about state entitlement programs is one simple question: Who wants to pay for expanded public retirement and health care entitlements?
It's a question that union organizers, doctors, teachers, state legislators and governors across the country grapple with as inflation takes a bigger bite of fixed incomes, market returns fizzle and the federal government cuts back on Medicaid payments after expanding welfare rolls through the stimulus and ObamaCare. And while liberals try to make the case that entitlements play little part in the current state budget battles, simple math says otherwise. Medicaid makes up the second-largest part of many state budgets, if not the largest. In fact, if governments used the same math that private pensions are mandated under the law to use to figure their liabilities, experts say the entitlement shortfalls in states' pension systems is two-to-three times larger than has been widely reported.
Federally mandated Medicaid spending that is busting this year's budgets in every state is the biggest story today. But fuzzy pension math is potentially the gravest budget killer. The Heritage Foundation points out that, while it cost less than $1 trillion to shore up the financial system in the bank crisis of 2008, "the IMF expects that, on net, present value basis -- that is, the deflated total of all future costs," the entitlement gap "will amount to about 34 percent of the U.S.'s GDP." That's equal to $5 trillion of today's GDP. Bill Gross, the manager of the world's largest mutual fund, recently sold all of his fund's holdings in U.S. government securities after estimating total U.S. government debt at $75 trillion, including off-the-book items such as Social Security, Medicare and Medicaid.
How did we fall into such a hole?
Take the average teacher who enters the work force at 25 years old and who retires at the age of 65. Even assuming Social Security will be there at retirement, the teacher's savings, accumulated at 10 percent of his salary for 40 years, must enjoy rates of return near 6 percent to ensure a retirement income equal to 70 percent of the salary he first enjoyed when he entered the workforce. From 1925-2004, the safest investments -- U.S. treasuries -- have returned only 3.7 percent. Corporate bonds have averaged 5.4 percent (see "Chart 1: Historic Rates of Return, 1925-2006").
The riskiest investments average near 10 percent but are not suitable for a state-managed pension program. Nor are they reliable. Dizzying rates of return in the 1990s, in part, have led to assumptions about market returns that are unsustainable. As a result, politicians have been able to use fuzzy math to hand out bigger benefits to public employees.
It would be nice if everyone could afford to open up a bed and breakfast with their retirement savings, as was depicted in retirement-planning commercials of the late 1990s. However, historic rates of return in markets don't allow for expansive retirement dreams. ...
In Florida, for example, the state currently assumes that its pension system will return 7.75 percent annually, according a report by Milliman, an actuarial consultancy located in Vienna, Va., that tracks pension obligations (see "Chart 2: Estimated Real vs. 'Official' Pension Gap in Florida").
But private pension plans currently can assume only a 5 to 6 percent rate of return -- approximately the same rate of return that corporate bonds get historically. ...
One of the complicating factors of the entitlement crisis is a willful blindness that has government conveniently overestimating tax revenues during recessions, in addition to overestimating rates of return at all other times.
"During the 1990-92 revenue crisis, 25 percent of all state forecasts fell short by 5 percent or more," finds the Rockeller Institute report "States' Revenue Estimating: Cracks in the Crystal Ball." "During the 2001-03 downturn, 45 percent of all state forecasts were off by 5 percent or more. In 2009, 70 percent of all forecasts overestimated revenues by 5 percent or more."
If Bernie Madoff had used such sloppy account methods in his Ponzi scheme as state governments do in estimating pension liabilities and revenues, no doubt his house of cards would have collapsed more quickly. If anything, government accounting methods are hurting those people liberals claim to care so much about -- low-income workers -- by creating huge entitlement deficits that require cuts in benefits that will impact those who will have the hardest time retiring. ...
Tinkering around the edges of our demographics won't help that much if politicians aren't willing to come clean as to the size of the problem that faces us in the future. Neither party has shown a real willingness to tackle entitlement reform yet, although some on the GOP side of the aisle have shown that they understand the scope of the problem and the potential difficulties.
"Is this a political weapon we are handing our adversaries? Of course it is," GOP House Budget Chairman Paul Ryan, Wis., said in March. "I think everybody knows that we are walking into I guess what you would call a political trap that arguably we are setting for ourselves ... but we can't wait. This needs leadership."
That passes the verbal portion of the test. Now, if they could just pass the math portion.
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