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Changes in management of finances needed to solve state pension crisis

Mark Reutter, Business & Law Editor
217-333-0568; mreutter@illinois.edu

Fred Giertz
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University of Illinois photo
Solving the pension crisis will require “broad-based changes” in the way the governor and Legislature manage state finances, according to J. Fred Giertz, an economist at Illinois.

4/18/2005

CHAMPAIGN, Ill. — The pension crisis roiling Illinois, which has caused Gov. Rod Blagojevich to propose cutting billions of dollars of anticipated retirement benefits to future state employees, has been a long time coming.

For at least 20 years and across four governorships, Illinois hasn’t been paying enough into its five pension funds to cover the retirement checks promised to state workers, schoolteachers, judges and university employees after they retire.

The upshot has been a wave of accumulated shortfalls that, temporarily masked by high stock-market returns in the 1990s, has returned with greater force.

This year the state faces $1.8 billion in retirement and debt service contributions to the pensions systems, and contributions are expected to jump to $2.3 billion in fiscal 2006.

Solving the pension crisis will require “broad-based changes” in the way the governor and Legislature manage state finances, according to J. Fred Giertz, an expert at the University of Illinois at Urbana-Champaign.

Giertz, a professor of economics, faults the historic use of the pension funds to plug holes in the state budget and laments how employee costs at state agencies and school districts have been shifted to the pension system through such devices as early retirement programs.

“The accelerating cost of funding Illinois’ public pensions is a manifestation of the state’s fiscal problems rather than the root cause,” Giertz wrote in an article in the current issue of Illinois Issues, published by the U. of I. at Springfield.

“Focusing narrowly on public pensions will lead to inferior solutions to the state’s underlying fiscal weaknesses,” Giertz said. “Soon the state of Illinois must face the prospect of making large and painful cuts in major state programs – not just cuts in pension benefits decades in the future – or finding additional permanent revenue sources.”

Illinois ended fiscal year 2004 with a 60.9 percent funded ratio, which left a $35.1 billion gap between the cash assets of the retirement programs ($54.7 billion) and what the programs are legally obliged to pay out in pensions to current and retired employees ($89.8 billion).

Only West Virginia is below Illinois in terms of its unfunded pension ratio.

Blagojevich has recommended various ways to reduce pension costs, including cuts to the retirement benefits of future employees. According to Giertz, the governor has cast the crisis as “the result of overly generous benefits bestowed in a haphazard way by past legislatures and governors.”

But in fact, the pension problem “should be viewed more as a general state budget problem that manifests itself in high costs because the state’s pension systems have been used in the past to mask more basic budget issues,” Giertz wrote.

Underfunding of the pension systems can be traced back to when James Thompson was governor. “This was done explicitly during the austere budget days of the 1980s when Gov. Thompson and the General Assembly chose to direct available state resources to other state programs rather than to pensions. This was not an oversight, but a conscious policy decision.”

Facing a pension crisis a decade later in 1995, the state enacted a law to bring the pension systems up to 90 percent of full funding by 2045, but left the actual funding ratio low for the first 15 years of the program.

“While the 1995 plan was a step in the right direction,” Giertz noted, “it was like an overweight person deciding to go on a diet, but delaying any reduction in calorie consumption until 15 years in the future.”

The crisis therefore is not the result of an upswing in pension costs, but a matter of catch-up needed to correct years of accrued liabilities caused by past fiscal decisions.

While the cumulative pension shortfall cannot be laid on the doorstep of the present administration, Giertz faults Blagojevich for “increasing the difficulty of the state’s fiscal challenge by vowing not to increase state income or sales taxes and not to cut the state’s most expensive programs: aid to primary and secondary education, health care or public safety.”

Blagojevich’s decision in June 2003 to sell $10 billion in general obligation bonds and to use the proceeds to invest for state pension contributions may or may not prove to be beneficial; it depends on how well the investments perform over the life of the interest-bearing bonds, according to Giertz.

By focusing public attention only on reducing pension costs in his budget address this year, the governor is again taking a gamble. He faces the legal hurdle of the “impairment clause” of the state Constitution, which prohibits reducing or impairing the retirement benefits of current employees.

As a result, most of the governor’s efforts are directed at reducing pension benefits far in the future. Although his proposals are likely to save the state money in the long run, the savings are being counted by the Blagojevich administration in the current year’s budget.

“In a sense,” Giertz concluded, “this is business as usual: Pensions are again being used as a device to defer costs, while at the same time they are blamed for creating the state’s fiscal woes.”

A professor in the Institute of Government and Public Affairs, Giertz is a board member of the State Universities Retirement System (SURS), which covers employees at state universities.

SURS is one of the five defined-benefit pensions systems for which the state is responsible for employer contributions. The others are the Downstate Teachers’ Retirement System (TRS), State Employees’ Retirement System (SERS), Judges’ Retirement System (JRS) and General Assembly Retirement System (GARS). The five systems have 311,000 active members, and there are currently 172,000 recipients of retirement, survivor and disability benefits.

Giertz’s article, titled “Cause as Solution,” appears in the April issue of Illinois Issues.