American Cities and States Must Promise Less or Face Disaster

August 14, 2013

Many people think Detroit is such an exceptional case that it holds few lessons for other places. But other states and cities should pay heed, not because they might end up like Detroit next year, but because the city is a flashing warning light on America's fiscal dashboard. Though some of its woes are unique, a crucial one is not. Many other state and city governments across America have made impossible-to-keep promises to do with pensions and health care. Detroit shows what can happen when leaders put off reforming the public sector for too long, says The Economist.

Nearly half of Detroit's liabilities stem from promises of pensions and health care to its workers when they retire. American states and cities typically offer their employees defined-benefit pensions based on years of service and final salary. These are supposed to be covered by funds set aside for the purpose.

  • By the states' own estimates, their pension pots are only 73 percent funded.
  • That is bad enough, but nearly all states apply an optimistic discount rate to their obligations, making the liabilities seem smaller than they are.
  • If a more sober one is applied, the true ratio is 48 percent.
  • And many states are much worse: The hole in Illinois's pension pot is equivalent to 241 percent of its annual tax revenues: for Connecticut, the figure is 190 percent; for Kentucky, 141 percent; for New Jersey, 137 percent.
  • By one recent estimate, the total pension gap for the states is $2.7 trillion, or 17 percent of gross domestic product.

That understates the mess, because it omits both the unfunded pension figure for cities and the health care promises made to retired government workers of all sorts. In Detroit's case, the bill for their medical benefits ($5.7 billion) was even larger than its pension hole ($3.5 billion).

Cleaning up the mess in local and state government will take time. Circumstances vary widely from place to place, but a good starting point would be to abandon the accounting tricks. Only when the scale of the problem is made clear can politicians persuade voters of the need for sacrifice.

Source: "The Unsteady States of America," The Economist, July 27, 2013.

 

Browse more articles on Tax and Spending Issues