Originally published at Forbes.com on August 7, 2019.
It’s easy-peasy, really.
There’s a way to reduce the Illinois and Chicago pension liabilities by half, with no constitutional amendment required, no hard political truth-telling or compromises, no cuts at all.
And considering that Chicago’s pensions are 23% funded, and Illinois’, 40%, this is not a minute too soon.
Here’s the scoop:
The basic structure of Illinois’ and Chicago’s pensions are the same. In general, Tier I employees/retirees, those hired before 2011, receive a pension based on final pay and service with a fixed 3% per year Cost-of-Living Adjustment; whenever inflation is lower than this (the last ten years, it’s averaged 1.8%, the last 20 years, 2.2%), they come out ahead, to the extent that some retirees get pension checks greater than any paycheck they ever received. Tier II employees, on the other hand, keep the same benefit formula, but averaged out over a longer period of time, receive pseudo-COLAs at half the rate of inflation, without compounding, and have their pensionable pay capped at a level that (unlike, for instance, the Social Security ceiling) doesn’t rise based on average wage growth or even inflation but at half the rate of inflation, so that, to take the teachers as an example, any teacher who earns above-average pay levels will be affected as soon as 2027, based on current inflation projections and average wage data.
Now, the value of any pension without a true CPI-based cost-of-living adjustment will be eroded over time due to inflation, and eroded in very short order in instances of high inflation. And in countries with a history of inflation, employer-sponsored pensions are more likely to include true cost-of-living increases. In some cases, the entire actuarial valuation is done on a “real” basis, evaluating all of the inputs on the basis of “value in addition to inflation” — that is, using the assumed salary increase in excess of inflation and the interest rate in excess of inflation. When both these hold true – true-CPI increases and assumptions all relative to inflation, in principle, neither the liabilities nor the pension benefits’ real value are affected by fluctuations in inflation. (Random trivia: in Brazil, the government even issues its bonds on a “real” basis.)
At the same time, back in the spring, the latest buzzword was Modern Monetary Theory (here’s an explainer), which was the means by which various progressive politicians promoted the idea that there was an awful lot more room for government deficit spending than appears to be the case; concerns about inflation were waved away with the assurance that the government would be able to tack as needed by increasing tax rates.
You see where I’m going with this, don’t you?
If the United States were to hit a period of high inflation rates, sustained over a long period of time, these liabilities would shrink considerably — and I’m not even speaking, snarky photo aside, of hyperinflation. Based on my calculations (and yes, these are real calculations, using real data for this plan collected for another project, not merely back-of-the-envelope estimates, however unlikely the very even numbers make it appear), an inflation rate of 10%, and assumptions for interest rate/asset return rate and salary increases over time which reflect the same net-of-inflation rates as at present, would halve the pension liabilities of the Illinois Teachers’ Retirement System.
Sounds preposterous, I know. And admittedly, beyond all the ill-effects of high inflation, individual state governments don’t control monetary policy anyway. But is it really any worse a proposal than the idea of selling the Illinois Tollway to a private firm which would do the dirty work of raising tolls so as to indirectly fund the pensions by making the tollway an attractive and profitable purchase? Or more ill-conceived a notion than the notion that public pensions can function perfectly well as pyramid schemes in which each cohort of employees funds their predecessors’ benefits?
Or maybe the politicians of Illinois have some better idea? If so, I’m all ears.
December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.
The first thing to help solve Illinois pension woes is to make retirement age 65 for everyone. Thirty years of service is not enough to fund retirement. Very few people in the private sector retire before 65. Social Security does not kick in fully until 66. Why should government pensions start earlier.
In 2013, 35.7% of men and 41.3% of women signed up at age 62.
My problem with all this is as always hypothetical numbers..let’s talk reality. The vast majority pay into social security that’s a much lower payout then pensions and cola is not a guarantee for most seniors who need those increases as much a those pensioners. Difference is that those dependent on their social security pay for it in their taxes while working..and in most cases,they also pay into the fund for these government and education based pensions as well with little or as in most cases no participation in those payouts. It is an unfair system as social security recipients are mandated into their contributions and the pensioners in many cases don’t participate in their own retirement windfalls. It’s all smoke and mirrors and the divide is not a fair or equal plan
Let’s assume your assumptions are spot on. It’s a race to what comes first, bankruptcy or inflation? If possible, apply your assumptions to States who have elimated/suspended COLAs – ie NJ…..seems like their unfunded liability is running neck and neck with IL!
The only reason NYC avoided bankruptcy in the 1970s is the high inflation of that decade cut the value of retroactively increased pensions and debts run up in the 1960s in half. Basically the CPI doubled in 10 years. This benefitted Baby Boomers and hurt their poorer parents (remember “seniors on fixed incomes?”) Read to the end of this post for a discussion of how that happened.
https://larrylittlefield.wordpress.com/2017/05/30/deblasios-2018-nyc-budget-detroits-bankruptcy-and-nycs-recovery-from-the-1970s/
Now low inflation is benefitting Baby Boomers and hurting their poorer parents. This is not an accident.
Meanwhile in NYC all those retroactive pension increases of the late 1960s (culminating in a big one for teachers in 1970) have been repeated. The cost is being hidden and put off, and lied about. There is nowhere in the U.S. that past taxpayers are less guilty, and the public unions more guilty, with regard to the public employee pension disaster, and it isn’t even close. No other taxpayers have paid more for pensions.
https://larrylittlefield.wordpress.com/2018/12/16/sold-out-futures-by-state-public-employee-pensions-in-fy-2016/
Or paid more in state and local taxes over the decades.
https://larrylittlefield.wordpress.com/2018/12/20/sold-out-futures-by-state-the-sold-out-future-ranking-for-2016/
Illinois is not broke. It chooses to spend $3 Billion each year on state services to foreign citizens residing in Illinois. These costs are not mandated by an Illinois Supreme Court decision, as are state worker pension contracts. See map: https://thefederalistpapers.org/us/new-map-cost-illegal-immigration-state-2
This is a ridiculous article! And you dear, are as bad as our politicians. You basically are hoping to screw the retiree so you can actuarialy resolve under-funding. Sure, leave the pensioner short on real income 15 or 20 yrs into retirement so you can call the pension funded! And BTW, anyone who manages retirement funding knows a CPI-based COLA is not reflective of reality as the share of expenses in retirement is more heavily weighted to healthcare, which rises in cost much greater than CPI. Also, curious where you are seeing a pensioner making more in retirement than working as a result of the COLA exceeding CPI? Certainly this allows a net “gain” for the pensioner, but for example CPD takes out 75% of salary at retirement (with full time, 29 yrs), and I believe ISP is 80%. Who in the system is retiring with benefits at 100% of salary at retirement so this net COLA gain would have them making more than when they were working?!?!? You sound like you’re too deep into the actuarial forest to see the trees…