Public Pensions: The Crisis No One is Talking About with Laurence Msall

You've heard Illinois is in the midst of a public pension crisis, but do you know how we got here? Special guest Laurence Msall, president of the Civic Federation, a nonpartisan government finance think tank, walks us through the history of the problem and what our government can do to dig Illinois out of its pension hole.

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Q & A with Laurence Msall

Andy Shaw: I'm Andy Shaw, President and CEO of the BGA and I'm joined today by Laurence Msall, President of the Civic Federation, a nonpartisan government research organization. Laurence is our expert on a topic that is one of the most vexing of our time, public pensions. With his help, we're going to address how we got here, where things stand, and where we could go from here. Welcome, Laurence and thanks for joining us on Ready Set Gov.

Laurence Msall: Thanks For having me.

Andy Shaw: Let's start at the beginning and keep it simple. A lot of people don't have pensions–many wish they could or did–tell us in simple terms what a public pension is.

Laurence Msall: A public pension is a form of economic security. It's the retirement plan for government employees in Illinois. Basically, most of the public employees receive something called a Defined Benefit Pension. That means that when they start working, they make a contribution and their employer makes a contribution and their final retirement determines what that benefit will be. It's not tied to the returns of the pension fund. It's tied to how long they've worked for the state or the city or the fire department, how much their average salary was at the end of their career, and then a factor is determined.

Andy Shaw: So That part's good, in a sense, that it doesn't depend on the performance of the stock market. The beautiful part of the pensions in Illinois, is you get a 3% automatic compounded increase every year regardless of the cost of living. How much has that contributed to the problem we face today?

Laurence Msall: Most government employees in Illinois receive a 3% compounded automatic increase. The Chicago police and firemen and women do not receive 3% compounded. They receive 3% simple. It's a very expensive benefit that Illinois has added to all of its pensions over the years. The benefit of a Defined Benefit Plan for the government is it should be cheaper to provide that benefit if you make the contributions beginning when the employee starts and you have a realistic expectation as to what you're going to have to pay out to that employee once they retire. Illinois got into trouble because we had unrealistic expectations for how long people would live. We had unrealistic expectations how much the benefits would increase by having a 3% compounded and we compounded our problems by not funding according to what the actuaries said was the expected cost of the benefit program. Instead, we created in state statute other formulas that were not based on actuarial best practice but were generally what the elected officials, the legislature, the City Council, and others thought they could afford.

Andy Shaw: So When we hear that there's an unfunded pension liability well north of 100 billion dollars. Does that mean that if everybody retired tomorrow we'd be 100 billion dollars short of paying it off?

Laurence Msall: If everybody retired who was owed a state pension right now and they went to go collect it, it would be 130 billion dollars that the Illinois State Treasury does not have.

Andy Shaw: Now what's the biggest culprit here Laurence. Is it the government's failure to pay into the plan or the 3% compounded or the lack of good returns on the investments or the funds or is it all of that together?

Laurence Msall: The biggest factor is this government's unwillingness or inability to fund the pensions. If we had funded these pensions from the very beginning at 100%, which is what well-run states and well-run pension funds recommend, we probably would not have added benefits that were more expensive than we could handle. We would have been able to absorb short-term losses in our investment returns. But certainly, the generous benefits that Illinois provides including the 3% compounded automatic increase contributes to the rapid decline of the pension funds.

Andy Shaw: So you've got the three factors: you've got poor return on investments, the 3% guaranteed, and the failure to pay into the fund. One hundred and thirty billion dollar unfunded liability; it's a huge number to people, nine zeros after one hundred and thirty. Why should we care? Why does it matter? Why is it more than a number?

Laurence Msall: It's more than a number because it represents to the outside world what the liability of the state of Illinois is. Again, that 130 billion dollars is only for the state employees and the downstate and suburban teachers. It doesn't include the city of Chicago or Cook Counties or even the local police and firemen's pensions. It's just the state employees in the three major state funds. But it shows that the state is highly leveraged and as a result it affects our credit rating and the government needs to borrow money on a regular basis and how it's determined how much interest they have to pay is based on the credit rating. So Illinois, which has the lowest credit rating of any state in the United States, pays a much higher premium whenever it goes to market to borrow which generally issues bonds sometimes enters into letter of credit short-term borrowing. We pay more in order to borrow those funds when there's the perception that we're not going to pay all of our bills like Illinois has gotten into the problem. We need to borrow more money in order to just keep up with our cash flow.

Andy Shaw: And The other issue, of course, is as we increase our governmental contributions to pensions to pacify the credit agencies and take some of the pressure off, we eat further and further into the revenues that are necessary for the rest of government. My understanding is it's almost doubled in the last decade from 10 or 11 or 12% of the budget to more than 20%. What is the real pain of this pension crisis on a day to day basis for regular people?

Laurence Msall: Well it's basically what drove the state budget crisis the last two and a half years. Such a large percent of the state budget has to go into to make pension contributions. There's not enough money for higher education; there's not enough money for mental health services. People want to fund education more and provide more for elementary and secondary schools. There's just not enough money. The state basically had been collecting about 31 billion dollars a year. Now it's collecting about 37 billion dollars a year. A larger and larger portion of that has to go into the pensions.

Andy Shaw: OK So we've talked about this for years. We've talked about fixes. Legislature passed a bill a couple of years ago, Governor Quinn signed it. Looked like we might be on the road to some sort of a solution. Civic Federation supported it. BGA supported it. Almost everybody did. And the court said sorry unconstitutional. What was the problem there legally?

Andy Shaw: Legally, the problem was that we never really had a hearing on the actual issues. It was an expedited ruling. The state asked for an expedited hearing. There was no trial record on it. The judges basically did not read the amicus briefs that were filed by 10 different organizations. Friends of the court both labor management and business groups all said, "we have a crisis" and had different perspectives. Our elected Supreme Court said, "no." If we're going to deal with this in an expedited fashion, we are not going to read the amicus briefs. So they rejected them. Then they looked at the Constitution and said, "this is what we believe the Constitution says." It was a very difficult decision. Most other states that have had similar pension reform legislation, their elected Supreme Courts found ways to work with the legislature. At the very moment, the Supreme Court was deciding the case about whether we could change the pension benefits, we let the temporary income tax increase expire so we could not use the argument effectively any longer that Illinois had done everything possible. It had raised taxes that had cut services. No, we were saying that we've done everything possible. But the temporary income tax we let expire. So many members of the court said you can't say Illinois done everything possible. We're not even going to have to get to that issue to decide whether Illinois has done everything possible. They're not following the letter of the Constitution. We reject them.

Andy Shaw: So both of our organizations are apolitical and non-partisan. So let's not get too political about this but from where you sat watching this as closely as you did, was that a good, sound legal decision? Or was that a political decision to protect state workers from benefit reductions? They are mostly supportive of Democrats and the court is 4-3 Democrat.

Laurence Msall: I can't really point to it as a partisan decision or not. I can say it's a status quo decision. The court did not entertain whether the state even with a tax increase would be able to afford the benefits that they say couldn't be changed. They never addressed the fact that how could it possibly be illogical that the legislature can change every law except that related to pension benefits. How can it add benefits but not take benefits away. There's no balance there. They rely on what they believe the voters were thinking about in 1978 when they voted on an entirely new constitution. There is no evidence to suggest that people understood that they were changing what was formerly a gratuity into a contractual right to say it was the perfect trap. You could never get out of it once the benefits are added.

Andy Shaw: So you do have the option of altering the constitution. We can by referendum ask the voters of Illinois if they want to change the constitution and let us change that benefit structure I presume it will be negotiated. Why haven't we seen an amendment on the ballot so the voters could decide?

Laurence Msall: It's been very difficult to match the progress that has happened for instance for the lockbox amendment for transportation. The Illinois General Assembly thought that making sure that transportation funds was the highest priority the state had protecting them so that it could only be used for transportation-related causes. They put that on the ballot with almost no opposition and they amended our constitution with about two new pages of qualifiers on what specific taxes could be used how they could be changed how can they be held. There hasn't been that same appetite to address the pensions. The original pension legislation that went before the Supreme Court did not include the Supreme Court's very generous pension benefits that has provided. That was felt that that would allow them to be more objective as they were reviewing the case. But the fact that we let the temporary income tax expire while the justices were being pressed to decide the case, took away a very valuable lever that they might have had. It's a very difficult thing. Illinois doesn't make it easy to get on the ballot for independent, elected officials. It doesn't make it easy to get on the ballot for independent changes to the Constitution. We saw with the Independent Maps redistricting over 600,000 Illinoisans signed on to just put the question to the voters as to whether they could amend the constitution to allow for a more fair and balanced district map drawing for our legislators and for other units of government. The Illinois Supreme Court found that we did not meet that standard.

Andy Shaw: You're one of the best budget experts in the state. Let me ask you this: we raised the income tax back to just about its previous level probably brings in five or six billion dollars a year. Does that stanch the flow? Does that keep the unfunded liability almost flat and keep it from getting worse? Is that just like a thumb in the dam?

Laurence Msall: That income tax increase basically buys the state of Illinois time. More important than the decision to raise the income tax up to 4.95% for individuals, was that we were going to actually have a budget. Because when Illinois doesn't have a budget, it's not the same thing as saving money. Not having a budget is not the same thing as not incurring liabilities. The state constitution clearly says that no one can receive compensation or payment from the state of Illinois without appropriations. Yet, our members of the General Assembly and the governor agreed to pay all of the state employees without appropriations. They agreed to continue to pay all sorts of things without specific appropriations. That was a clear violation of most people's understanding of the state constitution. But there was no avenue for people to seek that redress. We racked up 16 billion dollars in unpaid bills over the two plus years we didn't have a state budget. The temporary income tax is only enough to not grow that number and it will only not grow the unpaid bills if we don't spend more than we take in if we have some discipline in our future growth of expenses.

Andy Shaw: Well we don't seem to have that discipline now depending on whose numbers you look at. We have a 1 to 2 billion dollar shortfall in this budget. Promises of pension savings from a little tweak won't take effect for a couple of years not this year. There's going to be the added cost of borrowing at a double rate than the budget suggested. So we really are still in crisis mode right?

Laurence Msall: Illinois is definitely in a financial crisis. Anyone from outside the state looks at it and says, "you have now perhaps 10 to 11 billion dollars in unpaid bills. You still have 130 billion dollars in unfunded pension liability. You have a plan to try to pay that off over the next 30 years, through a statutory funding formula but you don't have a plan for how you're going to make the education appropriations next year, what you're going to do if sales tax revenues don't pick up. There's not a comprehensive plan for the state going forward."

Andy Shaw: Let's go back to something you said earlier: we've only been talking about the state unfunded liability. If you add in Chicago, Cook County police and fire. You're talking what another $40 or $50 billion?

Laurence Msall: Approximately, yea. Twenty-five billion dollars for the main city pension funds and then another 10 to 15 if you include the County and all the other police and fire.

Andy Shaw: Are Chicago and Cook County doing a better job of confronting its pension crisis than the states done? I know the Mayor's raised a number of taxes. The county board has raised a number of taxes. I think will strike the pop tax from that list for now. But are the mayor and the county board president actually confronting this crisis in a more professional and mature way than the state legislature is? Or are they all just kicking the can down the road?

Laurence Msall: Both the mayor and the president of the county board went to Springfield as they're required to do. It's important to understand that the city pension crisis and the county pension crisis were created by the state legislature. The Chicago Public Schools pension was created by the state legislature the pension holidays that have been improved over the years are approved by the state legislature and signed into law by various governors. Nothing related to pensions can be changed or improved unless the Illinois General Assembly and the Governor signs off on those improvements. So Mayor Emanuel had to go to Springfield not only to say please let me raise taxes but please let me use money that I'm going to raise from the water fees or from the 911 surcharge and put them in the pension funds. Prior to that, he did not have state authority to put money other than property taxes into the pensions.

Andy Shaw: Is This a collective failure of leadership at all levels?

Laurence Msall: This is a collective failure of recognizing the financial reality of making politically-generated, short-term decisions without looking at the long-term financial consequences. It's the easy answer to a complicated problem. It's the expectation that someone else is going to pay our bills just because they're too big for us to handle on our own.

Andy Shaw: So let's just say for the sake of argument that having raised taxes in the past year and elections coming up, taxes are anathema to everybody but we did it. We're unlikely to impose another big tax. So let's take that off the table for the moment and just wind this up with a couple of thoughts about where we could go from here. I remember a term that is of course says is as mind-numbing as "unfunded liability" used to be the so-called "ramp" which was a schedule for repayment of pensions which I guess in shorthand makes it more expensive to pay now because we paid less twenty years ago more or less. Is there a way we can adjust the payment schedule to take some of the pressure off of the current budget? So we're not gouging public education and all the other services to fund pensions. Do we have any wiggle room on the payment schedule?

Laurence Msall: It's the payment schedule that has put Illinois in this predicament. It's the idea that you can schedule it that you can somehow say when you owe 130 billion dollars by waiting to provide the 130 billion dollars it will be easier for someone later to pay them. Unfortunately, because of compound interest and the inability to have the assets–remember when we talked about how you fund a pension? You had defined benefit pension is funded by the employee contributions and the employer contributions being available for investment over time when you don't put the money in the investment fund, it can't earn a rate of return that's necessary in order to afford the employee right now. So pushing off you know contributions when you're so grossly underfunded now will not make it cheaper for the future taxpayer. It will make it much more expensive. We have basically been pushing our obligations out onto our children and grandchildren. But now there's not enough time in our grandchildren and our children are growing up and they're confronting the fact that we have this 130 billion unfunded liability. So no there are very few easy answers. There are no politically attractive answers that allow you to say someone else is going to pay for this week just through sleight of hand make this obligation go away. We can't amend the constitution to give the General Assembly the authority in a crisis to reduce the rate of growth of the benefits. That's probably as far as we can go.

Andy Shaw: Well, there is one election for a Supreme Court justice in the next year. I suppose if that changed hands you might have a change of interpretation. No more kicking the can down the road. The Governor is talking about kicking the can a thousand miles to Washington D.C. to see if Congress could provide any assistance. That's been proposed by a number of others. Basically saying the federal government has unlimited resources it can run up deficits to any level it wants. Why doesn't it do one of a couple of things either pass a law that trumps what the state Supreme Court says or come up with a pot of money that could be loaned to states like Illinois to pay down the unfunded liability? What do you think of going to Washington in the hopes of some sort of potentially legal solution that would obviously involve either a major statutory change or a big pot of cash?

Laurence Msall: Well a lot of people thought when Barack Obama was first elected president that somehow his urban agenda or his interest in having been from Illinois would allow the opportunity for maybe there being some sort of federal solution. The only solution that would have been reasonable would have been a large pot of money. That large pot of money did not appear during the Obama administration. It's unlikely that it's going to appear in the current administration. If you look at Puerto Rico which is a territory of the United States it found itself in terrible financial shape. There is no provision in the United States Bankruptcy Code for states to file for bankruptcy protection. That is by design. It's not just the Illinois delegation that you would have to convince it to support some change in order to allow Illinois to get out from under its pension obligations. It would have to be a majority of the United States Senate. United States House of Representatives the Congress basically and the President of the United States.

Andy Shaw: Is it time for that?

Laurence Msall: It's not the time for that in a lot of other states. So is Illinois crisis a self-inflicted crisis is the way other states look at it something that the federal government should take on? The same reason that the Illinois Supreme Court can't say Illinois has done everything possible. It's unlikely that the federal government is going to change all the rules because the state of Illinois has been financially reckless. This is a self-imposed wound to the state of Illinois. It is not the biggest challenge the state of Illinois has ever faced. It's not the biggest challenge or United States government has ever faced. It is a man-made mathematical problem that requires tough decisions: sacrifice as well as a commitment to not replicate the problem going forward.

Andy Shaw: I'm tempted to be very depressed about this but I refuse to because you and I both have to come back tomorrow and keep working on this you and your way, my in mine. Thank you for so much insight. Is there anything an individual listener to this podcast can or should do?

Laurence Msall: Sure, they should contact their legislators they should make sure that their legislators understand that their priorities are education transportation whatever they may be but then they have to hear how are you going to fund pensions and meet my priorities and ask them how they're going to do that.

Andy Shaw: Thanks, Laurence.

Laurence Msall: Thank You.