I frequently write about the state of multiemployer plans in the U.S. There is a “grading” system that makes it easy to identify more successful plans (Green) from those that are in trouble, which are defined in not so favorable terms as Critical and Declining. Regrettably, we don’t have a similar warning system for our public funds, although many of us know that states such as Connecticut, Illinois, and my home state, New Jersey, would certainly not receive a grade of green, but likely one that has them more appropriately designated as being on life support.
Pension plans used to be managed like a lottery system where future promises (liabilities) were known and a present value calculation was used to determine the assets needed to defease that promise. Those assets were then basically set aside until the promised payout was due. Regrettably, we’ve gotten away from that course of action and decided that generating the highest return was the more effective approach to ensuring that future promises were funded and paid. Unfortunately, what has happened is that the funded status for these systems has deteriorated, returns have fallen short, plans have had to reduce benefits, add tiers, and contribute significantly more to these pension plans.
Many of the states have resorted to significantly increasing taxes to meet their pension promises. How has that worked? Well, according to data from the US Census Bureau, millions of Americans have fled high-tax states, such as Connecticut, Illinois, New Jersey, and New York to find more economically palatable locations, such as Texas, whose population growth was greater during the last decade than all of Connecticut. In fact, four of the six highest-tax states in 2010 were among the nine with population growth below 1 percent for the decade in which the US’s population grew by 6%. None of the 10 states with population growth over 11% for the last 10 years were among the 20 highest-tax states early in the decade and it shouldn’t be surprising to read that four were among the seven with no personal income or investment taxes.
So if public pension systems think that they can continue to ramp up taxes on their residents without consequence they will be sadly mistaken. Those days are over. Pension systems need to reduce the volatility of the plan’s asset allocation and the variability in both funded status and contribution expense. Doing the same old, same old has proven to be an unsuccessful approach. It is time to go back to the future! We can help!