State and local governments are chomping at the bit to receive a share of the $350 billion reserved for them in the latest COVID-19 stimulus bill. Rather than addressing real pandemic needs, however, this bailout only offers a crutch to those states and localities that have engaged in decades of fiscal irresponsibility, especially when it comes to their mounting pension liabilities.
While state and local governments cannot put their stimulus directly towards pensions, depending on how the federal government enforces this restriction, they will still have the leeway to free up money that can then go toward pensions (or be spent on budgetary items that have been cut in recent years due to growing pension obligations). It sends a strong signal that the federal government is willing to backstop the widespread, reckless refusal by some state and local leaders to contribute enough money to pay workers what they’re owed upon retirement.
Even with the restrictions, this stimulus bailout will only reward bad budgeting, encourage spendthrift behavior going forward and leave state and local governments even less prepared to weather future downturns. Bailouts signal little need to prepare for recessions with responsible budgeting and rainy day funds. And they signal little need to properly fund pension promises, and even to transparently report these obligations.
This legislation also makes a direct federal bailout of pensions more likely in the future, thanks to the $86 billion going toward private sector multi-employer pension plans. By rewarding state and local governments who willfully turn a blind eye towards their pension (and other fiscal) problems, we would bring an end to the last-remaining fiscal discipline imparted by federalism, and leave financially responsible states on the hook for financially irresponsible states like Illinois, Kentucky and New Jersey.
Despite its size, this stimulus won’t solve the underlying budgetary problem, either. In fact, it will likely make this worse, too, by encouraging the very practices that created our pension crisis in the first place. Public pensions will continue to use overly optimistic assumptions about how their investments will perform, accounting tricks that mask the true size of pension liabilities, and underreport how much money is needed to fund them.
They will also continue to expose themselves to risky investments in order to attempt to shore up funding gaps. In fact, as the fiscal health of pensions plummeted following the 2008 financial crisis, plans only doubled down on the practice. In 2018, stocks, alternative investments, commodities and real estate — risky investments by pension standards — made up 74% of state and local pension plan portfolios, up from 70% in 2008.
In our forthcoming book, “The Political Economy of Public Pensions,” we show that public pensions are driving toward a fiscal cliff with over $4 trillion in unfunded liabilities. As we’ve seen with the financial crisis and now COVID-19, pensions are not structured to weather downturns.
While no one could have predicted a pandemic, public pensions ought to withstand a recession that, quite thankfully, only experienced a temporary and modest drop in GDP. States with better-funded pension plans, a history of responsible budgeting, and sufficient rainy day funds — like Tennessee and Nebraska — were far better prepared to serve their residents during the pandemic.
If policymakers really want to address the underlying problems, they should start by requiring public pensions, like private sector funds, to report their liabilities using realistic assumptions and conservative actuarial techniques. Of course, the only sure way to protect our public employees from the untrustworthy promises of politicians and the ups and downs of the business cycle is to transition them toward accounts owned and controlled by employees. Rather than betting on risky investments, individuals can tailor their investment strategy to their own needs and risk tolerance.
We can’t keep state and localities honest if we engage in bailouts every time there is a crisis, no matter how we restrict the use of those bailout funds. This applies even in an unexpected, pandemic-induced recession, the magnitude for which every state and local government should have been prepared.
Daniel J. Smith is the director of the Political Economy Research Institute at Middle Tennessee State University and an associate professor of economics at the Jones College of Business. Eileen Norcross is the vice president of policy research at the Mercatus Center at George Mason University.
