Be Afraid, Be Very Afraid: The “Nuclear Solution” to Underfunded Public Pensions

With few exceptions, state and local pension funds are woefully underfunded. Five heavily populated states—California, Illinois, Ohio, New Jersey, and Texas—collectively lack $431.5 billion; money that won’t be paid out to hopeful pensioners. That’s according to those states’ own accounts published in a 2012 Harvard University study that was led by former Assistant Treasury Secretary Tom Healy.

And the real numbers may be even worse: Accounting for current low interest rates, Healy and his coauthors estimate that the true extent of underfunding is $1.26 trillion.

When your tab is floating in the nebulous zone between $431.5 billion and $1.26 trillion, does the exact number really matter? Either way, you can’t pay it. Even wrapping your mind around numbers that large is difficult—like trying to visualize distances described in light-years.

In an understandable move to protect their interests (read: limit future tax liability), corporate heavyweights including Dow Chemical, ExxonMobil, Google, and Walmart sponsored a three-day judicial conference on public pension reform at George Mason University School of Law last month. One headline from the conference agenda: “Bankruptcy: The Nuclear Option.”

If the “nuclear option” scares you, it should. Still, some cash-strapped state governments are pushing for it.

A Political Solution Is Unlikely

The upside of a republican form of government—like we have here in America—is that it’s difficult to get much done. That’s also its downside. There’s a lot of political maneuvering among pensioners, union representatives, taxpayers, corporations, and politicians themselves, but very little progress has been made to find a long-term solution to the pension problem.

The union position is simple. The public employees they represent upheld their end of the bargain, and now it’s up to the legislators to find the money to uphold theirs.

Where? In his report The Plot Against Pensions, liberal columnist David Sirota suggests redirecting the “$80 billion a year states and cities spend on corporate subsidies” toward the $46 billion annual public-pension shortfall.

Corporate leaders see things a bit differently, of course. They say reducing corporate subsidies or raising corporate taxes would hamper business development and lead to lower employment rates.

Like the unions, they blame state and local politicians for not properly funding their pension programs in the first place. Both have a fair point.

The Plot Against Pensions vs. the Plot Against Jobs

What Sirota didn’t mention in his report is that corporate subsidies attract and retain much-needed jobs. One Illinois school district nearly learned that the hard way. In 2011, District 300 rallied to end $14 million in annual tax benefits for Sears Holding Corp., the parent company of Sears, Kmart, Land’s End, and other brands.

Sears promptly countered by threatening to move its corporate headquarters out of Illinois if the state ended the tax advantages it had enjoyed for 23 years.

And it wasn’t an idle threat either. Office Max, which recently merged with Office Depot, started moving 1,600 jobs out of Illinois last month after the state refused millions in tax breaks the company had requested.

Smaller businesses are getting out of Dodge too. Deron Lichte moved his 100-job business—Food Warming Equipment Co.—to Tennessee to escape Illinois’ 2011 income tax increase and its hefty corporate income tax—the highest in the nation.

The Little Guys Are Walking Too

Speaking of taxes, individual taxpayers are no more inclined to pay for underfunded pension promises than corporations are. Just like Office Max, Illinois residents are voting with their feet. And why shouldn’t they?

Legislators can’t hike taxes indefinitely to cover underfunded pensions and other government debts, and then gasp in surprise when their constituents walk. In fact, my wife and I sold our Illinois home because we were fed up with the high taxes.

In the book How Money Walks, author Travis H. Brown writes that from 1992 to 2011, Illinois lost $31.27 billion in taxes per year because former residents like myself refused to put up with its predatory taxation.

The same goes for New Jersey, which according to wealth management firm RegentAtlantic Capital lost $5.5 billion in taxable income in 2010 alone because residents moved out of state, often fleeing the state’s “millionaire’s tax.”

Plus, US citizens from all 50 states (including one member of our team) are now heeding the call of Puerto Rico’s alluring new tax benefits.

States and cities can’t tax their way out of the public pension crisis. More and more people will simply get up and move. Would the last person out the door please turn out the lights?

A Radical Solution That Will Never Come to Pass

While campaigning, Illinois governor Pat Quinn pledged to cut government expenses instead of raising taxes. We’ve heard that many times before, of course, and true to form, shortly after taking office, Quinn gave raises averaging 11.4% to 35 staffers. The public howled, so Quinn back-pedaled, giving the staffers 24 days off without pay so their salaries would ultimately stay the same.

Apparently it never occurred to Quinn that if 35 staffers can do their jobs with an additional 24 days off, he might be overstaffed. If all politicos are this financially pragmatic, don’t expect a pension-funding solution anytime soon.

The Nuclear Option: State Bankruptcy

Federal law allows local governments to seek Chapter 9 bankruptcy protection so long as state law permits it where the municipality is located. Cities like Stockton, CA, San Bernardino, CA, and most famously Detroit have already taken this path.

On the other hand, federal law doesn’t offer states bankruptcy protection—and it probably wouldn’t be constitutionally sound if it did. State-level bankruptcy is a scary thought—but it isn’t all that far-fetched either. Mainline politicians like former House Speaker Newt Gingrich and former Florida Governor Jeb Bush have both supported it.

There are obstacles, though: Congress would first need to amend the bankruptcy code, individual states would need to authorize application of that hypothetical law, and the Supreme Court would have to rule on whether the contracts clause prohibits states from declaring bankruptcy even if Congress allows it.

I don’t expect this particular nuclear bomb in my lifetime. I can’t say the same for my grandsons, on the other hand.

Your Shelter from the Fallout

There are real-life people depending on these underfunded public pensions. While I’m still flabbergasted that anyone would rely on promises made by the government, these public employees will suffer from the fallout.

I would suggest that every public employee should immediately—as in yesterday—start charting a private path to retirement. If those pension checks are there when you retire, they’ll be a welcome bonus. But don’t rely on them.

For that matter, private- and public-sector employees alike should independently prepare for their retirement. The only person you can rely on is you—and all it takes to turn that self-reliance into a low-stress retirement is a working knowledge of investing and personal money matters.

It is possible to plan ahead and get a steady flow of income every month, even if your public pension checks never come in and whether or not you’re still working. My team of analysts has put together a special report called Money Every Month that details how you can get a regular “paycheck” by investing in certain stocks—which we name in the report—according to a certain schedule.

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