Tuesday, December 30, 2008

Of Ponzi Schemes, Social Security, & State Budgets – What’s The Dif? And, Illinois in Trouble

We now see a stream of terribly sad stories about the gullible and greedy taken in by the latest Ponzi scheme (Madoff), perhaps the biggest private one of all time not counting that which the Detroit “automakers” are still running to support their retirees. My thoughts invariably turn to the government –run, perfectly legal kind. Lots of things we don’t condone in private affairs, like Ponzi schemes and gambling, seem perfectly acceptable when run by government.

Social Security is, of course, the greatest Ponzi scheme of all. There are already many people receiving money for every one of us still putting in, and as the receivers increase in number, so must the contributions from that one worker stuck with the tab. Soon we will reach the point of failure when the whole artifice collapses – either the few, relatively speaking, remaining workers will revolt and refuse to bear the burden for which they did not bargain, or the money will run out. With most voters anesthetized to high taxes by the alluring though illusory security and comforts of the overreaching liberal mommy state, my bet is on the latter.

State and local governments also run big Ponzi-like schemes – their own retiree benefit obligations. Workers retire after 25-30 years and receive a pension for life of perhaps 80% of their most recent wage. This was acceptable to our elected officials, and to us by extension, when towns and states were growing in population, year after year. But the music stops, as it has for some places already, when the new money flowing in is exceeded by the money flowing out. We’re about to see what this looks like in a lot more places.

Steve Malanga, senior editor at the Manhattan Institute's City Journal, recently wrote (November 18; link) in the Wall Street Journal about the extent of the problem for states. Basically, states overspend relative to revenues, don’t put aside enough money for future obligations, and meet obligations incurred long ago and now come due not with saved money but with current revenues. The most significant such issue for states, writes Malanga,
…is their failure to deal with huge and growing employee pension and benefits liabilities…. For years, state and local politicians have bought support from public sector unions by promising big benefits. Over time these promises exert severe pressure on their budgets. A study three years ago by the Employee Benefit Research Institute estimated that the average public sector worker earns 46% more in total compensation than his counterpart in the private sector, largely because government employers spend 60% more per worker on benefits than counterparts in the private sector…. States have collectively racked up some $731 billion in unfunded liabilities for pensions and other retirement benefits, according to a study published last December by the Pew Charitable Trusts' Center on the States. In particular, the states have been promising their employees rich nonpension benefits -- such as retirement health and dental care -- and paying for virtually none of it. According to Pew estimates, states have put aside a mere $11 billion to fund $381 billion in future nonpension benefits.
Illinois is not faring so well, as states go. Here’s Malanga:
Illinois has attempted to deal with a nearly $2 billion budget deficit in part by slowing down payment of its bills (its backlog of unpaid invoices was recently $1.8 billion) and hoping tax collections would revive. Instead, they are declining and the state's budget gap is widening…. Illinois, which has the largest percentage of unfunded pension liabilities among the states, actually cut its contributions to pension funds by $2.3 billion in the flush years of 2006 and 2007 as stock market returns were rising.
How about that. In recent years, the State of Illinois has actually reduced the amount it sets aside for its future obligations. Well, the Blagojevich affair has Illinois legislators somewhat distracted at the moment. When that show is over, their attentions will return to the state’s financial crisis. With Democrats in control of the legislature and governor’s office, we’re likely to see significant tax increases and little to no spending cuts, which will only aggravate the budget problem in the long term, since we can’t tax ourselves into prosperity.

John M Greco