Fox's Varney Claims Pensions Are “Biggest Reason” States Facing Budget Crisis

Varney: “Pensions Paid To Retired State Workers Are ... The Biggest Reason Why They're Being Pushed Into This Financial” Crisis. From the January 21 edition of Fox News' America Live:

MEGYN KELLY (host): Why are we going right to bankruptcy or some form of bankruptcy? Why aren't we looking at things like pension reform? I mean -- was it California that just announced all these amazing cuts, all these spending cuts and tax penalties and yet didn't touch the pensions?

VARNEY: All the spending cuts and the tax increases combined will not be enough -- the money is not there. Illinois -- totally run out of money, $8 billion in debt to its vendors. So you need something now. The crisis is upon us. Urgent action required.

KELLY: Who gets hurt most when the states -- if they -- let's not call it bankruptcy necessarily, but if they do something akin to bankruptcy, who's the number one victim of that?

VARNEY: Very probably unions and those pensions which they're expecting to receive. Pensions paid to retired state workers are one of the biggest expenses that states have and the biggest reason why they're being pushed into this financial -- this state. They would be the losers. The primary losers. [Fox News' America Live, 1/21/11]

Current State Budget Problems Are Result Of Financial Crisis, Not Pension Obligations

SF Reserve Bank: “The Deep Recession Placed A Severe Strain On State Revenue ... Further Widening Budget Gaps.” A June 2010 report by two economic analysts at the Federal Reserve Bank of San Francisco stated:

The causes and severity of fiscal crises vary, but two primary circumstances have affected every state to a greater or lesser extent. The most obvious is the profound macroeconomic shock that hit all states. The recent recession was one of the sharpest economic contractions in U.S. history. Real GDP fell by 3.8% while nonfarm employment fell by 6.1%, or about 8.4 million jobs, from peaks registered around the start of the recession until they bottomed out. Moreover, the unemployment rate essentially doubled, going from 5% at the beginning of the recession to a peak of 10.1% in October 2009. The economic distress was not uniform across states. Many, especially those in the West which had greater exposure to the housing downturn, suffered more dramatic declines. Other states fared better than the nation overall. Still, no state escaped the effects of the downturn.

The deep recession placed a severe strain on state tax revenue. Figure 1 shows real state and local tax receipts growth and real GDP growth from 1970 through 2009. As GDP declined sharply, state and local tax revenue essentially collapsed. In fact, at the worst point in the recession, real state and local tax receipts fell over 10% on a year-over-year basis. While tax revenue always declines or grows more slowly during recessions, the fall during the latest recession was the most severe since at least 1947, when these data began to be collected. Furthermore, reports from states on April tax collections, the largest tax revenue month for most of them, paint a gloomy picture for 2010. Many states report that tax receipts fell short of forecasts, further widening budget gaps. [Federal Reserve Bank of San Francisco, 6/28/10, emphases added]

The Federal Reserve Bank of San Francisco report provided the following chart showing the effect of a decline in real GDP on state and local tax receipts:

[Federal Reserve Bank of San Francisco, 6/28/10]

CBPP: “States Continue To Face Large Budget Gaps” “As A Result” Of Recession. According to the Center on Budget and Policy Priorities (CBPP):

As governors across the country prepare their budget proposals for the coming year, they continue to face a daunting fiscal challenge. The worst recession since the 1930s has caused the steepest decline in state tax receipts on record. State tax collections, adjusted for inflation, are now 12 percent below pre-recession levels,[1] while the need for state-funded services has not declined. As a result, even after making very deep spending cuts over the last several years, states continue to face large budget gaps.

To date some 44 states and the District of Columbia are projecting budget shortfalls for fiscal year 2012, which begins July 1, 2011 in most states. These come on top of the large shortfalls that states closed in fiscal years 2009 through 2011. States will continue to struggle to find the revenue needed to support critical public services for a number of years, threatening hundreds of thousands of jobs. [CBPP, 1/21/11]

CEPR: Any State Budget Shortfall “Is Due Almost Entirely To The Recession Caused By The Collapse Of The Housing Bubble,” Not Excessive Pensions. A December 21, 2010, blog post on the Center for Economic and Policy Research's website stated:

On Sunday night, the CBS News show 60 Minutes joined this campaign. The piece begins by telling viewers that:

“in the two years, since the 'great recession' wrecked their economies and shriveled their income, the states have collectively spent nearly a half a trillion dollars more than they collected in taxes.”

That's not what the data show. If we look to the Commerce Department's National Income and Product Accounts we find that in total state and local government spent $45 billion more than they took in (line 27). CBS does not give a source for the “nearly half a trillion” number.

It is also worth noting that any shortfall is due almost entirely to the recession caused by the collapse of the housing bubble. If revenue had increased in step with normal growth (2.4 percent real growth, plus inflation), state and local governments would have had an additional $290 billion since the start of the downturn.

Another way to think about the size of the state and local government shortfall is that we could envision the Federal government giving state and local governments trillions of dollars in loans at below market interest rates as they did with the Wall Street banks through TARP and the various Fed special lending facilities. If the state and local governments got $3 trillion in loans at rates that were 4 percentage points below the market rate, and then they relent this money at market rates, it would largely make up for the shortfall in revenue they have faced. (It would provide them with $120 billion a year in additional revenue.)

When the governments repaid their loans, plus the below market interest, the Treasury and the Fed would then get all their money back, plus a small premium. This would allow people like Treasury Secretary Timothy Geithner and the Washington Post editorial board to declare that they made a profit, just as they have with the TARP. This would be one possible solution to the fiscal problems faced by these governments.

[...]

While some of us did try to warn of the risks that the housing bubble posed to the economy and financial markets (we were not featured on 60 Minutes, which was busy touting deficit stories even then), the primary fault of state and local officials was listening to Wall Street and the mainstream of the economics profession, not excessive pensions. [CEPR, 12/21/10, emphasis added]

Wash. Post's Klein: “In The Short-Term, The Problems Facing States ... Are Not Driven By Pensions Or Public Employees, But By The Financial Crisis.” In an October 12, 2010 blog post, The Washington Post's Ezra Klein wrote: “There are real challenges facing states in the coming years. But these are serious, complex challenges, not a simple morality play in which we just need to get tough with state employees and all will be well. In the short-term, the problems facing states -- the problems that are forcing them to stop construction of ongoing projects -- are not driven by pensions or public employees, but by the financial crisis.” [Voices.WashingtonPost.com, 10/12/10]

Pension Expenditures Account For “Only 3.8 Percent Of The Average State's Spending”

Center for Retirement Research: Pension Plans “Currently Account For Only 3.8 Percent Of The Average State's Spending.” From a 2010 study by Boston College's Center for Retirement Research (CRR) titled, “The Impact of Public Pensions on State and Local Budgets”:

[W]hereas public plans are substantially underfunded, in the aggregate they currently account for only 3.8 percent of state and local spending. Assuming 30-year amortization beginning in 2014, this share would rise to only 5.0 percent and, even assuming a 5-percent discount rate, to only 9.1 percent. [CRR, “The Impact of Public Pensions on State and Local Budgets,” 11/13/10]

CRR provided the following chart, which shows that in 2008 pensions accounted for 3.8 percent of state and local spending for the country as a whole:

[CRR, “The Impact of Public Pensions on State and Local Budgets,” 11/13/10]

CBPP: Current Pension Obligations “Average Only 3.8 Percent Of State And Local Budgets, An Amount That Pales Beside States' Largest Expenses.” A January 20 report from the CBPP explained that current pension obligations “average only 3.8 percent of state and local budgets, an amount that pales beside states' largest expenses.” From the CBPP:

As noted, current employer contributions for public employee pensions average only 3.8 percent of state and local budgets, an amount that pales beside states' largest expenses -- education and health care. Pension contributions are smaller than the amounts spent on transportation, corrections, and many other services. If all states and localities were to fund their pensions based on the “riskless” rate, Boston College researchers calculate that they would have to contribute approximately 9 percent of their budgets, on average. (This calculation uses 5 percent as the riskless rate. [33]) A contribution amount this high would cut into states' and localities' ability to provide other public services; it arguably would not strike the appropriate balance between funding currently needed services and funding past pension liabilities.

If states and localities continue to use an 8 percent discount rate for calculating required contributions, a funding increase to 5 percent of their budgets would be required on average to fully fund their pensions. This level is not likely to be unduly burdensome after the economy recovers, and states could reduce it somewhat by adopting various pension reforms. (States should not begin to increase their contributions while the economy is still weak, because the budget cuts this move would require would further slow the economy.) [CBPP, 1/20/11]

CBPP: Claims That Pensions “May Cause Localities To Declare Bankruptcy ... Overstate The Fiscal Problem” And “Fail To Acknowledge That Severe Problems Are Concentrated In” Just A Few States. The CBPP report further stated:

Some observers claim that states and localities have $3 trillion in unfunded pension liabilities and that pension obligations are unmanageable, may cause localities to declare bankruptcy, and are a reason to enact a federal law allowing states to declare bankruptcy. Some also are calling for a federal law to force states and localities to change the way they calculate their pension liabilities (and possibly to change the way they fund those liabilities as well). Such claims overstate the fiscal problem, fail to acknowledge that severe problems are concentrated in a small number of states, and often promote extreme actions rather than more appropriate solutions.

• § State and local shortfalls in funding pensions for future retirees have gradually emerged over the last decade principally because of the two most recent recessions, which reduced the value of assets in those funds and made it difficult for some jurisdictions to find sufficient revenues to make required deposits into the trust funds. Before these two recessions, state and local pensions were, in the aggregate, funded at 100 percent of future liabilities.
• § A debate has begun over what assumptions public pension plans should use for the “discount rate,” which is the interest rate used to translate future benefit obligations into today's dollars. The discount rate assumption affects the stated future liabilities and may affect the required annual contributions. The oft-cited $3 trillion estimate of unfunded liabilities calculates liabilities using what is known as the “riskless rate,” because the pension obligations themselves are guaranteed and virtually riskless to the recipients. In contrast, standard analyses based on accepted state and local accounting rules, which calculate liabilities using the historical return on plans' assets, put the unfunded liability at about a quarter of that amount, a more manageable (although still troubling) $700 billion.
• § Economists generally support use of the riskless rate in valuing state and local pension liabilities because the constitutions and laws of most states prevent major changes in pension promises to current employees or retirees; they argue that definite promises should be valued as if invested in financial instruments with a guaranteed rate of return. However, state and local pension funds historically have invested in a diversified market basket of private securities and have received average rates of return much higher than the riskless rate. And economists generally are not arguing that the investment practices of state and local pension funds should change.
• § A key point to understand is that the two issues of how states and localities should value their pension liabilities and how much they should contribute to meet their pension obligations are not the same. The $3 trillion estimate of unfunded liabilities does not mean that states and localities should have to contribute that amount to their pension funds, since the funds very likely will earn higher rates of return over time than the Treasury bond rate, which will result in pension fund balances adequate to meet future obligations without adding the full $3 trillion to the funds. In fact, two of the leading economists who advocate valuing state pension fund assets at the riskless rate have observed, "...the question of optimal funding levels...is entirely separate from the valuation question." [2] The required contributions to state and local pension funds should reflect not just on an assessment of liabilities based on a riskless rate of return, but also the expected rates of return on the funds' investments, as well as other practical considerations. As a result, it is mistaken to portray the current pension fund shortfall as an unfunded liability so massive that it will lead to bankruptcy or other such consequences.
• § States and localities devote an average of 3.8 percent of their operating budgets to pension funding. [3] In most states, a modest increase in funding and/or sensible changes to pension eligibility and benefits should be sufficient to remedy underfunding. (The $700 billion figure implies an increase on average from 3.8 percent of budgets to 5 percent of budgets, if no other changes are made to reduce pension costs. [4]) However, in some states that have grossly underfunded their pensions in past years and/or granted retroactive benefits without funding them -- Illinois, New Jersey, Pennsylvania, Colorado, Kentucky, Kansas, and California, for example -- additional measures are very likely to be necessary.
• § States and localities have managed to build up their pension trust funds in the past without outside intervention. They began pre-funding their pension plans in the 1970s, and between 1980 and 2007 accumulated more than $3 trillion in assets. There is reason to assume that they can and will do so again, once revenues and markets fully recover.
• § States and localities have the next 30 years in which to remedy any pension shortfalls. As Alicia Munnell, an expert on these matters who directs the Center for Retirement Research at Boston College, has explained, “even after the worst market crash in decades, state and local plans do not face an immediate liquidity crisis; most plans will be able to cover benefit payments for the next 15-20 years.” [5] States and localities do not need to increase contributions immediately, and generally should not do so while the economy is still weak and they are struggling to provide basic services. [CBPP, 1/20/11, emphasis added]