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Wall Street Journal

 

How Retirement Benefits May Sink the States

April 28, 2012

By Steven Malanga

PRINTER FRIENDLY

Illinois is a lesson in why companies are starting to pay more attention to the long-term fiscal prospects of governments.

Chicago Mayor Rahm Emanuel recently offered a stark assessment of the threat to his state’s future that is posed by mounting pension and retiree health-care bills for government workers. Unless Illinois enacts reform quickly, he said, the costs of these programs will force taxes so high that, "You won’t recruit a business, you won’t recruit a family to live here."

We’re likely to hear more such worries in coming years. That’s because state and local governments across the country have accumulated several trillion dollars in unfunded retirement promises to public-sector workers, the costs of which will increasingly force taxes higher and crowd out other spending. Already businesses and residents are slowly starting to sit up and notice.

"Companies don’t want to buy shares in a phenomenal tax burden that will unfold over the decades," the Chicago Tribune observed after Mr. Emanuel issued his warning on April 4. And neither will citizens.

Government retiree costs are likely to play an increasing role in the competition among states for business and people, because these liabilities are not evenly distributed. Some states have enormous retiree obligations that they will somehow have to pay; others have enacted significant reforms, or never made lofty promises to their workers in the first place.

Indiana’s debt for unfunded retiree health-care benefits, for example, amounts to just $81 per person. Neighboring Illinois’s accumulated obligations for the same benefit average $3,399 per person.

Illinois is an object lesson in why firms are starting to pay more attention to the long-term fiscal prospects of communities. Early last year, the state imposed $7 billion in new taxes on residents and business, pledging to use the money to eliminate its deficit and pay down a backlog of unpaid bills (to Medicaid providers, state vendors and delayed tax refunds to businesses). But more than a year later, the state is in worse fiscal shape, with its total deficit expected to increase to $5 billion from $4.6 billion, according to an estimate by the Civic Federation of Chicago.

Rising pension costs will eat up much of the tax increase. Illinois borrowed money in the last two years to make contributions to its public pension funds. This year, under pressure to stop adding to its debt, the legislature must make its pension contributions out of tax money. That will cost $4.1 billion plus an additional $1.6 billion in interest payments on previous pension borrowings.

Business leaders are now speaking openly about Illinois’ fiscal failures. Jim Farrell, the former CEO of Illinois Toolworks who is heading a budget reform effort called Illinois Is Broke, said last year that the state is squandering its inherent advantages as a business location because "all the other good stuff doesn’t make up for the [fiscal] calamity that’s on the way." Caterpillar, the giant Peoria-based maker of heavy construction machinery, made the same point more vividly when it declined in February to locate a new factory in Illinois, specifically citing concern about the state’s "business climate and overall fiscal health."

California is another place where businesses have come to view three years of budget uncertainty and huge pension liabilities (not to mention the state’s already high taxes and complex regulatory regime) as an inducement to migrate elsewhere. The state and its municipalities already face unfunded pension bills that now top $500 billion, according to studies by Stanford University’s Joe Nation, and several of the state’s cities, including Stockton in the Central Valley, face the prospect of insolvency.

Executives at Stasis Engineering, a formerly Sonoma, Calif.-based auto design firm that left the state for West Virginia in the midst of an unfolding budget crisis in 2009, told the Press Democrat newspaper that the "budgetary bedlam gripping Sacramento" seemed to portend, as the paper characterized the company’s concerns, "a future filled with tax increases and service cuts." More recently, in December 2011, Ron Mittelstaedt, the chief executive of Waste Connections, a recycling company formerly based in Folsom, Calif., told the press that the state’s "structural [budget] mess" was a contributing factor in its decision to relocate to Texas.

Meanwhile, Oakland Tribune columnist Daniel Borenstein notes that his city has levied what he calls a "hidden pension tax" on property owners for decades to pay off a municipal pension fund that went bust in 1976. Today, the average Oakland home with an assessed value of $266,267 pays an additional $419 a year in property taxes to finance the benefits of the defunct system, Mr. Borenstein estimates, while a home assessed at $1 million pays an added $1,575 in taxes.

Bigger bills will fall due elsewhere. Earlier this year, the Massachusetts Taxpayers Foundation examined unfunded retiree health-care liabilities in 10 midsize municipalities, including Worcester and Springfield, and found the debt averaged $13,685 per household. To pay those commitments over 30 years would require adding $565 a year to property tax bills on average, the group estimated. In one community, Lawrence, the tab was $1,209 annually, a 50% increase over current taxes.

Back in Illinois, Dana Levenson, Chicago’s former chief financial officer, has projected that the average city homeowner paying $3,000 in annual property taxes could see his tax bill rise within five years as much as $1,400. The reason: A 2010 Illinois law requires municipalities to raise the funding levels in their pension systems using property tax revenues but no additional contributions from government employees. The legislation prompted former Chicago Mayor Richard Daley in December to warn residents that the increases might be so high, "you won’t be able to sell your house."

Original Source: http://online.wsj.com/article/SB10001424052702303592404577361891800868180.html

 

 
 
 

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