A Whale of a Problem

The stage now is set for huge conflict between state public-sector workers and taxpayers, and the reason is pension obligations.

Because almost all states are required to balance their budgets, general fund monies must be used to pay pension obligations if the pension funds come up short. They certainly will do that. The funds are generally underfunded, and make assumptions about fund returns that simply are not credible.

Utah has calculated it will have to commit 10 percent of its general fund for 25 years just to pay for the effects of the 2008 stockmarket crash, for example.

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States use the expected return on the assets in their pension funds as a discount rate. This is often around eight percent, and reflects the performance of the past 20 to 30 years.

However, such returns will be hard to come by in future. Given current bond yields of two percent and a typical portfolio with 60 percent  in equities and 40 percent in bonds, a total return of eight requires a return of 12 percent on equities.

With American equities yielding just two percent to 2.5 percent, that in turn would require dividends to grow by nine percent to 10 percent a year.

That simply is not plausible. In a state such as Colorado, nearly 55 percent of all funds will have to be spent on pension obligations, effectively reducing the amount of money available to fund on-going operations by fully half....IF investment returns come in at an overall eight percent.

That isn't going to happen. Nor do these forecasts take into account financial "black swan" events that destroy huge amounts of equity.

Who would bet that between now and 2022  there will not have been at least one major financial event that wipes out huge chunks of pension plan equity?

These forecasts are not realistic. Colorado will wind up spending most of its general fund revenues to pay pensions, unless something quite dramatic happens, and quite soon. That is not a "political" issue. It is a simple mater of public finance getting severely out of whack. Something will have to be done, and it won't be pleasant.

Either we get an unpleasant fix, or we decide now that in 12 years there is no money to fund on-going state government services.