Pensions: After years of overpromising and underperforming, state pensions face a yawning $1 trillion-plus funding gap. As states try to dig themselves out of this massive hole, they should look to the Great Lake State for a solution.
For years, Michigan had been racking up pension liabilities for public school teachers that it had no money to pay for. By 2016, the state’s unfunded liability had reached $29 billion — which meant state was funding only 60% of its pension obligations.
According to the Michigan-based Mackinac Center for Public Policy, pension costs eat up more than a third of the state’s school payroll budget.
Michigan is hardly the only state to have made this mistake. Pressured by public sector unions, state lawmakers boosted retirement benefits, using wildly unrealistic forecasts for investment returns and wage growth to justify them.
As a result, overall net pension liabilities rocketed up from $0 in 2001 to $1.1 trillion in 2015, according to Pew Charitable Trusts. Pew figures that gap hit $1.3 trillion in 2016 — and that might be conservative. Just eight states had funding levels above 90% in 2015, Pew data show, while 21 states didn’t have enough money to cover even 70% of their pension costs.
Illinois is in a state of crisis, with $15 in unpaid bills, a $6 billion deficit, and a pension liability that is now upwards of $130 billion. The state’s finances are so bad that it elected a Republican as governor to reform the state’s out-of-control pensions but who has met fierce resistance from the Democratic legislature.
Other states are hurtling toward an Illinois-style crisis. As of 2015, California’s pension liability was $174 billion, which is more than its annual budget. New Jersey $135 billion pension liability is more than twice the size of its state budget. Pennsylvania’s unfunded liability is $61 billion.
Needless to say, this is unsustainable.
So what did Michigan do to avoid Illinois’ fate? It embraced bold pension reforms that will protect taxpayers and provide a solid retirement benefit to teachers.
First, it’s shifting its public school teachers toward defined contribution plans. All new hires will be automatically enrolled in a 401(k)-type plan with a default 10% contribution rate. Teachers will still be able to opt for a traditional defined benefit pension, but one that splits costs 50-50 between workers and the state, and includes safeguards that will prevent the funding ratio from dropping below 85%.
The California-based Reason Foundation, which provided technical assistance to Michigan officials, says that while these reforms won’t by themselves close the current funding gap, they will prevent it from getting any bigger. Michigan, it says, is now “a model for teacher pension reform in other states.”
Will other states follow suit? That depends in part on whether voters in those states are willing to elect reform-minded Republicans.
The states with the biggest pension liabilities tend to be liberal ones more beholden to public sector unions, while states adopting elements of the reforms Michigan just approved — Florida, South Carolina, Arizona, Kentucky — are mostly solidly Republican. Pennsylvania also recently overhauled its pension program. Michigan itself couldn’t get its pension program reformed until voters gave the GOP control of both the legislature and the governorship.
No matter what, states that ignore this crisis face a grim fiscal future.