Illinois's "State Capacity" Crisis pt. 2
Pension Harder
In Part 1, I showed the immense scale of the State Capacity crisis, its broad, bipartisan creation, and how its chief driver is the pension crisis. In Part 2, I wanted to dig further into the pension crisis and what needs to be done to solve it and why current efforts have been minimal. Can we finally talk about pensions Mac, I’ve been dying to talk about the pensions!
On the right we have finger pointing at the long legacy of Democratic rule in the General Assembly and Governor’s Blagojevich and Quinn’s mishandling of the pension system. Through the leadership of Democratic Speaker Mike Madigan and multiple Democratic governors, this debt spiraled out of hand. On the left, largely silence. Government employees are a significant political faction of the Democratic party, maintaining their stability and not cutting benefits is a political necessity. State employees themselves feel that they were betrayed on what they worked hard for, at lower than private sector salaries for. To ask them to take a cut for something they had nothing to do with is quite an ask. So the only thing Democrats have found themselves doing on the pension front is making headline raising, multi-hundred million supplemental payments into the system. These are tiny contributions compared to the $139 billion unfunded liability the State faces or the worse funded ratios of county and municipal systems but provides political cover for Democrats on the issue. This is the worst form of politics. Band-aids and kludge to appease a dysfunctional coalition of special interest groups.
I will lay out a refresher for those out of the loop, a brief overview of several recent pension proposals, and a proposal of what should be done next.
A brief refresher on the Pension crisis and why it matters
Illinois’s 5 pensions systems for teachers, police, public employees, university employees, and retired politicians are in a state of crisis. On an aggregate level, they only have 43.8% funding level which means the pension funds have approximately 44 cents for every dollar they owe. This is down from a 52% funding level more than 25 years ago. In dollar terms, it's an unfunded liability of $139.7 billion. The greatest contributor of this has been insufficient state contributions, accounting for $57.92 billion in lost funding. Much of this is the result of the “Edgar Ramp”, a pension plan that was implemented in the mid-1990’s that did not contribute enough to meet actuarial minimums. It backloaded an enormous amount of debt to give the Edgar administration the veil of fiscal pragmatism. Coupled with poorer than expected returns early on due to the dot-com recession of 2000-2001, Rod Blagojevich stealing money from bond sales and refusing to pay in for multiple years, and other factors compounded this into an enormous and perilous debt.
Adding to these challenges was the “Tier II Pension System” rolled out in 2010. New hires after 2010 were given a different pension plan in order to make the system more long term sustainable by ultimately paying less money. This however is looking to backfire. Tier 2 benefits may be so low that they will trigger federal provisions regarding safe harbor provisions of social security; the fix of which could completely cancel the cost savings of these new pensions.
And what is the result of this debt? Inflation adjusted spending on State programs such as education, police, healthcare, and social services has declined by 16% since 2000. This decline in funding means that local governments have turned to sky high property taxes to fill in the gaps. While Illinois has made some school funding adjustments in 2017 to present, low levels of state investment coupled with high property taxes is the status quo for Illinois education revenue. K-12 schools have borne much of this, higher education has also seen significant budget cuts. As a percentage of revenue, state funding for universities in Illinois has declined more than half from 2002 to 2022; 72% to 35%. The resulting hike in tuition and fees has burdened many students with debt and restricted access to these opportunity factories. Worse, proposals to raise funding or to make these universities tuition free are hard to achieve given the constraints the pension debt places on us.
A reconstruction of State capacity would involve hiring many new public employees who would draw pension benefits. If we are to fill in the gaps of public schools and public hospitals, the staffing of regulatory and administrative agencies, police departments, and more we will need to create a solution to the pension crisis long term. The only way to attract these employees is how any other firm would: pay, benefits, and job satisfaction. We can’t be competitive to the private sector only appearing to those with a heart for public service (job satisfaction).
Pension Solutions: What’s been proposed and what they offer
Of course pensions aren’t a new problem in the State. I’m breaking down 3 recent proposals from 3 different organizations capturing a range of attitudes on the issue. They are from the Center for Tax and Budget Accountability (CTBA), Wirepoints, and the Civic Committee of the Commercial Club of Chicago (CCC). Each of these characterizes an ideological lane so to speak.
The CTBA plan represents the most state employee friendly and the least “painful”, only involving moving funding targets down to 80%, changing accounting practices to receive better asset returns, and recasting the debt which extends its period of payment at a different rate. Bond sales would be used to fill in the unfunded liabilities. Ultimately taxes and benefits wouldn’t be altered substantially; the bond sale and the re-amortization will do the bulk of the work. While this is convenient, it’s not certain how bond rating agencies would react to the State lowering its targets for pension funding by 10%. This could have long term ramifications for other areas of debt heavy spending, particularly infrastructure, by impeding the improving credit rating of the State. It’s also unclear how this bond sale raises enough revenue to salvage the unfunded liabilities. The largest point taken from this report however is that the State didn’t contribute enough early on resulting in a spiraling pension disaster. In the original Edgar Ramp, funding was so low that it was below actuarial minimums. But in this proposal, the bond sale will not be enough to cover 100% of benefits. I’m skeptical this isn’t a repeat of the past.
The Wirepoints proposal characterizes the most anti-state worker and right wing of the proposals. Their plan would first involve an amendment to the State Constitution that would allow pension benefits to be altered. Then the State would freeze all pension benefits for workers who have already earned them, transfer these employees and all new workers into a 401k style plan without a full state match, and now have them paying into social security which they presently don’t. Meaning that 22% of their salary will be set aside for their pension and social security. It then calls for a freeze in payment level for everyone in the retirement system receiving above $50k. Those below $50k would receive a 1% static COLA until they reach that 50k or the system has become 100% funded. This would give most pensioners and State employees in Illinois a serious haircut but would involve no tax increases. This complete transformation of the pension system would then be at 100% funding. There are several deep flaws. First, lets breakdown why the Constitutional amendment process wouldn’t succeed. State employees and their public sector unions are a major force in Democratic politics in Illinois. They would proactively campaign against this and likely succeed. Why would this change or what is the strategy to overcome that? How would this even be brought to a floor vote to be sent to the public in the first place? Second, how would this help our State Capacity crisis? The extreme, draconian cuts would be disastrous to many retirees. Public employees already don’t receive competitive compensation compared to peers in the private sector. Now they lose the guaranteed retirement benefit? How are we supposed to staff the government in this world? There is no evidence that Illinois pensioners are receiving extraordinary benefits compared to peer States, contemplating serious cuts to benefits seems vindictive. Of course, this kind of “starve the beast” logic is typical of right wing domestic politics. A decayed, atrophied State government is excellent for businesses. The problem all Republicans face in these debates is that the true threat of the pension crisis is to other Illinois services like our schools, public hospitals, and social services. But they want to cut those things too so it undermines any credibility they have in their proposals. “We gotta cut pensions before it forces us to cut welfare, which by the way I wanted to cut anyway independently of these circumstances.” Huh, wonder why Republicans aren’t getting anything useful out of the General Assembly!
The CCC proposal characterizes a business friendly, moderately right wing lane. I would also characterize this plan as the most “compromise” as it doesn’t involve a constitutional amendment or a significant cut to pension benefits but instead requires a 10 year 0.5% personal and 0.7% corporate income tax “surcharge” that would raise approximately $2.3 billion yearly that would be guaranteed, “lockbox style”, into the pension fund. This would save Illinois up to $37 billion over the next 22 years in pension contributions. First, a great deep cut to Al Gore there. Second, this would mean that the surplus revenue would not be able to be spent elsewhere but on pensions. This prevents a repeat of the Blagojevich blunder, the stolen bond sale that greatly exacerbated this crisis in the first place. Paying more now saves money later is a universally agreed upon principle between the three proposals. It also suggests a smaller provision to add retirement incomes above $100k to the tax pool which raises an additional $1.8 billion. In addition to these new tax proposals, they also float a requirement that the State increase the rainy day fund to $6 billion, in line with what many credit agencies say would raise our credit ratings even higher. This proposal is unique for first being a straightforward piece of bargaining from the business community. Refreshing to see movement from any side on the issue. Third, its unique for proposing *actually paying off the debt* through new revenue rather than using accounting techniques or slash and burn privatization schemes. However, this is where the trick of compromise comes: tax increases to sustain pension benefits. The business community is compromising with higher taxes and the State government is compromising by only using this revenue for pensions and raising our credit rating and fiscal health. This is politically dicey. Democratic voters who aren’t exposed to Chicago politics or aren’t connected to any pensioner directly likely won’t see it that way, and would be resentful of the tax increase. And Republican voters who want to see pensions cut and taxes go down wouldn’t be satisfied either. They want a pension cut and a tax cut.
So what’s your plan, smart guy?
I do not have the skill, education, or resources to possibly craft a comprehensive pension proposal. Allow me to speculate on one anyway. Here is what I think politicians, particularly Democrats, should be doing on pensions.
First: Begin developing a voter base open to tax increases and other big changes to the status quo. The chief challenge of these pensions in particular and the State budget generally is that we need more revenue to pay for more programs and service old debts. More staff, new infrastructure, and more social spending all takes more revenue. So the first step to solving the pension problem is getting a large chunk of the voting public to agree to the kind of tax hikes proposed by CCC. As we saw in 2020 and I’ve brought up before: Illinois voters rejected the Fair Tax Amendment in a presidential election year by 10%. We need to change the fact that the median voter is hostile to a tax hike. We also need voters to expand their imaginations of what is possible politically in Illinois. This is all done by media and political figures educating and arguing for this in the public forum. This is the first big task.
Second: Unify the Democratic caucus on a single pension plan. Factional disunity, a lack of effective party whips, herding cats; however you want to label it Democrats in Springfield are slow to act and hesitant for big bills. We need to get Democrats united in the General Assembly and the Governor on a *single* pension plan. This plan needs to have several major features that tackle previous failures and their resulting problems head on.
Get us to a 100% funding level to maintain both our fiscal health and our promises to our retirees. This will be necessary for our credit rating to continue to improve which is needed if you want to have large capital investments into public transit and energy production.
Have concrete revenue plans that will not be diverted or raided. Avoiding difficult decisions or pushing them off to later generations is exactly what produced this mess. Making sure that politicians don’t steal from us again must be a top priority. We must raise revenue, similar to that proposed by the CCC. However, using a progressive income tax would be preferable to the current flat income tax model.
Avoid draconian or significant curtailment in benefits for retirees. Public sector employment needs to be compelling to job seekers. Making retirement plans that are as gruesome as proposed by Wirepoints or bankrupting the system via inaction aren’t acceptable outcomes and will drive qualified people away. State employees had nothing to do with the pension being underfunded or stolen from. However, changing our 3% compound COLA to a static one, or capping benefits to 100k annually and freezing all those already above it may be necessary to bring spending in line with revenue so as not to be too punishing for taxpayers. We can’t expect taxpayers to shoulder 100% of the burden.
Keep pension costs as small a percentage of the State budget as possible. The chief problem of our ballooning debt is that other spending is being crowded out. The plan must take this fact as a guiding principle so that other necessary services aren’t being cut. Presently, 1/5th the budget. In 20 years it’ll be nearly half. How will we keep public universities or hospitals open in that world?
Solve the Tier 2 Social Security Safe Harbor compliance issue. This may be simpler than it seems, with some sources arguing it merely requires bureaucratic changes. Either way it must be addressed as soon as possible.
Third: Embrace a push for a completely new State Constitution. Changing pension plans or raising revenue outside the flat tax model need Constitutional changes. There are other compelling reasons for us to significantly change our Constitution but that’s for another post. Without the Democratic party getting behind a second progressive income tax amendment or a pension “cut” amendment, neither change is possible. Pritzker has attempted to douse the notion that such an amendment would work, citing the US Constitution’s Contract clause. However, other State’s have been able to do just this maneuver and today’s Supreme Court’s hard right nature and already long line of rulings against public sector workers, such as in Janus vs. AFSCME, gives me a cynical confidence that they wouldn’t rule against what will inevitably termed a public employee pension cut. This scale of change would require both #1 and #2 to be complete. Without a willing public and a unified party, this couldn’t possibly happen.
A joke to end the piece with. Go full populist: liquidate the politician’s pension fund and put 100% of it into the other 4 systems. They caused this mess, they can figure out their own retirements.
I’ll see you in the next one.