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OPINION | A bailout for Illinois? Not without strict conditions

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THE day the prophets of public finance long foretold has come to pass: Illinois has requested a federal bailout of its struggling public-employee retirement plans, which had unfunded liabilities topping $469 billion in 2018, according to a Federal Reserve study. As difficult as the coronavirus crisis has been for state governments and their pension systems, Washington shouldn’t bail out Illinois or any other perennial bad actor without first requiring stringent and permanent reforms.

The coronavirus downturn comes at a particularly bad time for state and local government pension funds, whose investments lost $419 billion in the first quarter of 2020 even as the government tax revenue that funds pension contributions plummeted. Despite years of rhetoric about funding reforms, most retirement plans are more poorly funded today than they were 10 years ago.

But some states are worse off than others, with Illinois long at the forefront of pension mismanagement. From 2001 to 2019, Illinois made only 80% of the actuarially determined contributions to its main state plan. Worse, Illinois assumed a roughly 8% annual investment return on those contributions, but received an average of only 5.2%. Over that same period, the average benefit paid to a retired full-career state employee rose from $41,700 to $49,700. Further, pensioners received a guaranteed 3% annual cost-of-living adjustment, even though the Consumer Price Index rose only 2.2% annually over that period.

What the Prairie State wants, according to a leaked April 14 letter written by Illinois Senate President Don Harmon to the state’s congressional delegation, is “$10 billion in pension relief, directly for the state’s retirement systems.” While making the obligatory noises about state efforts to restore pension funding, Mr. Harmon asks for federal grants or low-interest loans to keep Illinois’s pension plans afloat. If Congress bails out Illinois, you can be sure other poorly funded states like Connecticut, Kentucky and New Jersey would come asking for their own lifelines.

Given Illinois’s record of poor pension stewardship, Congress should reject any bailout on the merits. And yet the alternative might be worse. I have spent the past three years as a member of the federal Financial Oversight and Management Board for Puerto Rico, wrestling with the island’s 2016 insolvency, which included the exhaustion of its main public pension funds. A governmental bankruptcy is an ugly process from which no quick or clean resolution can be expected. Illinois’s unfunded pension liabilities substantially exceed its bonded debt, meaning that even a complete debt default wouldn’t put its finances back on track. A statewide economic contraction could also become a regional threat.

So Congress may want to offer assistance, but it should come with strict conditions: Any state looking for a pension handout must either live by the stricter accounting rules federal law imposes on private pension plans or freeze its pension and shift all employees to defined-contribution retirement plans.

Private-sector plans must assume more-conservative investment returns than public-sector plans and address unfunded liabilities more rapidly. As a result, private pensions today have set aside more than twice as much funding per dollar of promised future benefits than have state and local pensions. If adopted decades ago, stricter funding rules could have saved pensions such as Illinois’s. But today those states are in a bind: Many can barely make their contributions using the lenient public-sector funding rules, much less the stricter rules for private plans.

The alternative is what the Puerto Rico Oversight Board insisted on: Freeze the old pension to prevent any new benefit accruals while shifting all employees to 401(k)-like retirement accounts. Freezing a pension doesn’t make its unfunded liabilities go away. But it caps existing liabilities while shifting employees to plans in which the government’s funding obligation is clearly defined and can’t be evaded using actuarial or accounting tricks.

Illinois politicians will claim their state constitution prevents pension changes. But it was a misguided 1970 amendment to that constitution that made public pensions in Illinois a contract for life. By contrast, federal laws governing private pensions prohibit cuts to benefits that have already been accrued but allow employers flexibility to alter the rate at which future benefits are earned. Any assistance should be premised on constitutional or legal changes to align state pension rules with federal law.

It was perhaps inevitable that Illinois would someday come knocking on the federal government’s door looking for a pension bailout. Other states may follow. A governmental bankruptcy is a terrible thing, but federal assistance shouldn’t flow unless states fix their pension problems, once and for all.

Mr. Biggs is a resident scholar at the American Enterprise Institute.

November 2020 pssnewsletter

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