How to fix state pensions without a federal bailout

The November election sent a message of no more bailouts. Yet many states could default on debts in 2012, forcing a crisis. What can be done now?

If the November elections sent one clear message to Washington on what it should do in 2011, it is this: no more bailouts.

The federal rescue of Wall Street, General Motors, Fannie Mae, and sundry other entities drowning in red ink did not go down well with voters – even if a few bailouts did have a decent payback.

But the voters’ message could get lost if Congress is forced to deal with a likely crisis in the new year: states and cities that can’t pay their bills, especially the retirement benefits of state workers.

By this spring, many states will run out of the $217 billion in stimulus money from Washington. (Illinois is already a deadbeat in paying bills.) Their budget woes will only mount as joblessness persists and politics prevents solutions in state houses.

Most of all, they face an estimated shortfall of $3.23 trillion owed to pension plans for current and retired state workers. Municipalities have an estimated $557 billion in pension liabilities. That adds up to about a quarter of the yearly US economic output.

California, where the cost of state workers eats up about 80 percent of the budget, already asked Congress for an $8 billion bailout. Lawmakers wisely said no. Rewarding states for irresponsible promises of spending made during good times would only invite more irresponsible behavior in the future. And Washington can’t be a cash machine for local governments at a time when its own debts are reaching poor-nation status and jeopardizing an economic recovery.

Still, allowing one or more states – say, an Illinois or a California – to default on its debt would shock the US economy. The biggest hit would be on the $2.8 trillion market in municipal and state bonds, a source of financial security for many retirees.

Washington should not allow itself to be faced with a choice between bailing out a few defaulting states and letting such defaults send the economy into a downward spiral.

The first task is for states with high unfunded pension liabilities to act now.

The one state leading the way is New Jersey, where Gov. Chris Christie (R) is trying to cut a pension deficit of at least $46 billion (and another $76 billion in health benefits). He proposes rolling back a previous raise in retirement benefits while also requiring state employees to pay higher copays and 30 percent of their health-care premiums.

Maryland’s state pension commission proposed raising the years of service needed to qualify for retirement benefits from five years to 15 years. The commission also wants to shift some teacher pension costs to municipalities.

In Virginia, Gov. Bob McDonnell (R) faces a milder budget crisis but is asking state workers to chip in 5 percent of their pay to the state’s pension system. A few states are attacking the power of public unions, especially their influence over campaigns and in collective bargaining.

The sooner other states follow these examples, the better.

Collective bargaining may be necessary for private-sector unions, but they don’t make sense for employees of a monopoly – government – that represents the public. When union interests get on both sides of the negotiation table, taxpayers lose. This happens when politicians elected with heavy union funding are the ones in charge of fixing the benefit shortfalls.

To be fair, unions argue that in times like these, governments ought to find other places to cut, and then raise taxes to account for the rest. The difficulty is that most states are already down to bare bones with discretionary spending, and tax hikes risk scaring away revenue producing businesses. Plus, getting popular support for tax hikes is nearly impossible.

If states with strong unions refuse to make significant reforms, they would almost certainly ask to be bailed out. Letting the biggest states fail would be tough, but in case that does happen, there are better solutions.

If Washington must act, it will need to offer a loan, not a handout, and one with tough conditions enforced by an independent body. Just as the International Monetary Fund rescues a developing nation, so should the federal government use tough love with states.

These loans should have two general requirements: By the end of the loan, states must balance their budgets and have 10-year sustainability. This way, states wouldn’t go broke now but would be forced to make the necessary changes they refused to make before.

Rep. Devin Nunes (R) of California, Rep. Paul Ryan (R) of Wisconsin, and Rep. Darrell Issa (R) of California have also suggested another key reform to get change rolling. Right now, states are not required to publish an accurate accounting of their pension liabilities; these congressmen offer incentives for states to display these figures so voters can actually know what kind of mess their states are in.

Ending the bailout era will take continued vigilance from voters. To prevent states from collapsing, the public needs to pressure representatives to reform pensions and other benefits for state employees.

The best kind of change starts from the people – as Washington found out in the Nov. 2 election.

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