An increasingly large number of U.S. cities and states are facing a looming crisis after a funding hold in public pension systems soared by $432.0 billion. This is raising fears that some of America’s biggest cities and most populous states could face a Detroit-style bankruptcy.
According to the most recent data, U.S. public pension funds face a $3.85 trillion shortfall when it comes to paying the retirement benefits of current and retired workers. The issue is especially dire for a city like Chicago that has an unfunded pension liability equal to 19 years of the city’s tax revenues.
Chicago is not alone; major cities like Dallas, Fort Worth, New Orleans, and Philadelphia also have large, underfunded pension liabilities. Meanwhile, states such as Illinois, Kentucky, Hartford, and New Jersey face bankruptcy as expenses seriously outpace revenue growth.
Massive pension deficits have already helped push several major U.S. cities, including Detroit, into bankruptcy. Most recently, Puerto Rico, a U.S. territory, declared a form of bankruptcy after amassing pension obligations and debt of $123.0 billion.
Where structural deficits can be solved over time, pension deficits require an immediate influx of cash so the cities and states can pay their bills. To avoid bankruptcy, politicians will need to make tough, unpopular decisions to stave off future financial troubles. To fund public retirement plans, politicians may have to resort to raising taxes or cutting pensions benefits.
As it stands, though, municipalities and states are not willing to make tough decisions on public pensions. Of the 649 pensions plans studied for the 12 months ended June 2015, no U.S. city or state is running a balanced budget with regards to their pension plans.
A spokesperson for Orrin Hatch, chairman of the U.S. Senate finance committee, said this, “further underscores the financial risks of the nation’s public pension crisis and the need to act on smart policies that will help secure retirement programmes for Americans that work for state and local governments.”
Not everyone believes there is a crisis. Hank Kim, executive director of the National Conference on Public Employee Retirement Systems, said, “Pension funds are resilient if left alone.” (Source: Ibid.)
That hasn’t been the case of late, though. Pension funds estimate their liabilities based on future returns, and U.S. public retirement plans use an average annual return of more than seven percent. However, in the fiscal year ended June 2015, public pension plans generated average annual returns of under 2.9%.
In fiscal 2016, the funding deficit of public pensions was forecast to increase to $4.0 trillion. Because of the resilient stock market, the funding deficit for public pensions has been flat in 2017.
The large and increasing pension deficit could spell trouble for cities and some states as investors lose confidence and step back from buying the bonds of those cities and states. Large pension deficits also impact how much cities pay for essential services like schools and roads.
Many do not believe the underfunded pension deficits will lead to municipal or state bankruptcy and believe it will work itself out. But history is not on their side.
“US faces crisis as pension funding hole hits $3.85tn,” Financial Times, May 14, 2017.