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Start with the most important fact: Illinois' ginormous unfunded pension liability wasn't caused by any inherent aspect of the pension systems. That's right, neither the benefits promised nor the cost of paying for those benefits is to blame. Here's proof.
The current unfunded liability totals $83 billion because Illinois has only $63.6 billion in pension assets to cover $146.5 billion in pension liabilities. Expressed as a percentage, that's an aggregate funded ratio of just 43.4 percent. To be sound, public sector pension systems should be at least 80 to 90 percent funded. That's scary, but here's the eye-opener: If retirement benefits and salary increases were the only drivers of the unfunded liability, the state's retirement systems would be about 94 percent funded today. In other words, there'd be no pension crisis.
What Illinois really has is a debt crisis. Here's why. For decades, Illinois' poorly designed tax policy created an ongoing structural deficit. That means, adjusting solely for inflation and population, tax revenue hasn't grown at a rate sufficient to cover the increased cost of delivering the same level of services from one year into the next. This is somewhat amazing, given that despite having the fifth-largest population of any state, Illinois annually ranks in the bottom 10 in service spending.
To paper over -- without resolving -- the fact that its tax policy is so poor Illinois can't afford to be one of the lowest-spending states in the nation, decision makers funded public services by borrowing against what they owed the pension systems. In effect, the state racked up a ton of debt by using the pension systems like a credit card to pay for public services for which there was not enough tax revenue. By 1994, lawmakers had borrowed so much against pensions that the funded ratio was just 54.5 percent.
This benefited taxpayers in the short run by allowing them to consume public services without having to pay the full cost of those services, but the ever-growing debt ultimately had to be paid. Purportedly to rectify the problem, Public Act 88-0593 was passed in 1995. Known as the "Pension Ramp," it established a repayment schedule to get the pension systems 90 percent funded by 2045.
Unfortunately the Pension Ramp was fundamentally flawed, because it continued the practice of borrowing against pension contributions to fund services for 15 more years, effectively tripling total pension debt, and was so backloaded that the installments of debt to be repaid in out years jumped at annual rates that were unrealistic and unaffordable. For instance last year in FY2012, the state's pension contribution was $4.1 billion, of which only $1.6 billion was the cost of funding benefits, while more than half, $2.5 billion, was repayment of debt. In FY2013 the contribution jumps by 23 percent to $5.1 billion -- with all the increase being debt repayment under the goofy Pension Ramp.
The implication is clear: The problem won't be solved by cutting benefits, because benefits aren't the problem, the Pension Ramp is. Indeed, if the state had incurred this debt with a bank rather than the retirement systems, Illinois couldn't even try to make the bank's workers repay the state's debt, and couldn't have forced the bank to accept an unrealistic, unaffordable repayment schedule.