So Reuters reports that Jefferson County Alabama has filed for backruptcy becase of an usupportable $5,000,000,000 debt.  With 660,000 people in the county that’s about $7500 in debt per person.

Rhode Island has somewhere in the vicintiy of $30,000,000,000 in debt when you include the (true) penson liability ($18B) , the infrastructure debt ($9B), the ‘OPEB’ liablities ($??B), and whatever else we’ve yet to identify.  That’s probably well north of $30,000 of debt per person.

If we have four times the per capita debt load and they’re bankrupt, what does that make us?

The two categories listed in the title of this post are meant to be separate.  From some folks’ point of view, Rhode Island’s retirees are both young and wealthy, as a group, but with this post, my intention is to take a look at age at retirement and the dollar amount of gross pensions as separate topics.

Regarding the first, the average retirement age of the 26,598 included in the database that the Employees’ Retirement System of Rhode Island (ERSRI) provided to RIOpenGov.org was 58 — with an average gross pension of $33,388 and years retired of 13.  Of course, different careers tend to come to retirement at different ages, and Rhode Island’s many public employers vary in their generosity.

As is to be expected, police, fire, and rescue departments lead the list of youngest retirees, with the following top 20:

Teachers begin retiring a few years later:

Switching to rankings of retirees by the amount of their pensions, Superior Court leads the list:

As far as individual retirees are concerned, however, the top list is much more dramatically dominated by judges:

The Illusion of Public Sector economics

There is something important to keep in mind as we start down the path of debating pension reform in Rhode Island. It is perhaps not the most vital point in a debate where what really matters is “Truth in Numbers”, as Treasurer Raimondo puts it, but as a premise by which we frame the debate it is certainly worth noting.

The premise is that employees contribute to their pension plans. It is, in a very important way, false.

The premise is not unlike the related illusion that businesses pay taxes. They don’t. Not just in the Warren Buffet pays less than his secretary way. (Which is of course, baloney – he probably pays more sales tax on a dinner tab than the average secretary pays in income taxes in a year.) But rather, in the sense that corporations just pass through their costs to their customers.

It’s a failure to understand macro-economic concepts relating to the allocation of capital in a capitalist system that leads to this illusion. That may sound a bit high-brow, but really it just requires a bit of thought about human nature.

Imagine that you are going to invest in a business – perhaps you have $1000 in a 401k and you have to decide what stock to buy. You need to decide how much risk you’re willing to take and then look around to see what business will give you the best interest rate on your $1000 investment. Maybe you call an investment advisor to help sort it out.

That advisors job is to sift through the tens of thousands of companies out in the world and decide how risky they are and what return they generate. Since they can’t look at every company every time they need to get some advice, the market has created some short-cuts. Stock exchanges are probably the first layer of filtering. New York Stock Exchange listed companies have to be big and stable. The “Dow Jones Industrials” are an even more exclusive list of the power players.

There are other short-cuts as well. Things like “price-earnings” or “P/E” ratios give us an estimate on how much interest an investment n a company will pay. And different industries have different standards for where those P/E rations should be. Strong companies can pay out less interest because they are less risky. Speculative investments require higher interest rates to justify the risk.

So what does this have to do with corporations and taxes? Simply put, if you raise a tax on a corporation it doesn’t lower their earnings. They need to maintain the value of their stock, and that requires maintaining earnings. So what they do, along with all the other companies in their industry, is raise prices. So who pays taxes on Amazon, or Wal-Mart, or Big Oil? You do.

And what does this all have to do with pension contributions? It’s a different problem, but the same illusion. When a company “contributes” to an employee pension – say 50% comes from the employee’s paycheck and 50% from the “company” – it’s really just coming out of the employee’s pocket. If it weren’t for a variety of complicated and costly governmental carrots and sticks found in the tax code, the company would probable just as happy to give that cash directly to the employee. On their books “salary” and “benefits” are just two sides of the same coin. It’s what it takes to convince someone to spend eight hours a day on the shop floor or at a desk pushing paper.

In the end, the cost is the cost, and whether they pay it in the form of salary or benefits doesn’t really do much to impact their competitiveness. It may be convenient to have your employer pay for your dental insurance, or your retirement fund, or a disability plan, but if they told you they were just going to give you all that money directly – say a 30% raise – and you could buy it yourself, would that be a reason to turn down the job? Probably not.

With public sector workers the same illusion applies. They don’t “contribute” to their pension, even if their pay stub shows two percent or 10 percent or whatever the split might be. That’s just a slice of the cost of employing that person.

The problem we have with public employee pensions is not how we allocate the split – whether it shows up as 90/10 or 10/90 on a government workers pay-stub, 100% of the cost is coming straight out of your pocket in the form of taxes.

So – that was all by way of a preface.  Why I care about these type of illusions is because getting this basic economic perspective helps us understand the roots of the pension crisis.  The crisis stems from lack of (1) market controls and (2) limitations on worker rights that prevent us from knowing how much that employee is costing us and where the purported “contributions” are going.

The market controls are those described above – in the private sector businesses need to maintain profitability or no one will invest in them. They can’t risk making promises without properly funding them because of market transparency. If investors discovered a multi-billon dollar unfunded liability in a company with only a few billion in revenues coming in each year, that stock would plummet. Since that scares the heck ot of investors they require all sorts of private controls lke independant actuaries and outside auditors.

With a government, there is no such control. Ratings agencies provide same level of oversight, and the voters technically have a say in firing the leaders who caused the mess, but in reality there are not adequate incentives for the people to provide their own oversight. In Rhode Island, as elsewhere, actuaries are ignored or written off as doomsayers.  Worst of all, government finances are an impenetrable black box to most citizens.

The pension fund itself is another black box, and in effect it’s as if workers are not allowed to see what has been put aside for their retirement. There are promises of future payments of course, but since the money needed to keep those promises is not there when a pension system is not properly funded the retirees can only hope that the checks will show up each week.

Essentially the state has taken the pension money and frittered it away by not funding the pension system. If a private investment firm did what the state did somebody would be led away in handcuffs. In the private sector a retiree has the right to sue a trustee that was supposed to be managing their money in good faith. It’s an interesting legal question as to whether a state pensioner could sue state officials for breach of their fiduciary duty. The retirement board’s own actuaries have stated publically that the projected returns are more likely than not unachievable – they tell us that we have a 42.5% chance of seeing a 7.5% average rate of return, but they’re still basing our reform plans on that bad assumption. A 42.5% chance of getting the promised pension check? Is that a risk retirees should be happy with? My suspicion is that they expect odds somewhere above 90%, and if so they are not wrong to hold such expectations (And wold they be wrong to demand such certainty?)

Shouldn’t the retirement board be held responsible for placing workers pension checks at risk? If not, then what’s the point of calling them trustees?

In the end, we are the victims of these illusions. The pensioners of the state of Rhode Island and it cities and towns have been mis-led to by politicians and union bosses who knew what was going on. They had a view inside the black box, and told the workers who were relying on their professional oversight that everything was fine – that their contributions were earning interest and were adequate to fund a stable retirement.

Really it was a lie on top of a lie. The contributions were not made and the black box was just another insider’s piggy-bank.

***

Rhode Island’s pension system sent $142,159,475 directly out of state, in 2010, to the 4,575 public-sector retirees who live elsewhere. That’s according to the RI Center for Freedom & Prosperity’s new RIOpenGov.org section on pensions. Overall, government pension payouts amount to approximately 1.7% of Rhode Island’s gross state product (GSP), and 17.2% of them support the economies of other states, with the following top 10:

The pension dollars lost to Rhode Island’s economy are of particular concern during this era of high unemployment and sluggish economic activity, when it seems as if political actors feel they must couch every argument about public policy in terms of economic stimulus. In the debate over pension reform in Rhode Island, National Education Association Government Relations Director Pat Crowley got ahead of the pack by telling GoLocalProv on October 21 that freezing cost of living adjustments (COLAs) would “be a major drain on the Rhode Island economy.” The following week, the Brown Daily Herald noted the point being made in the wave of Finance Committee testimony. The assertion, in brief, is that if retirees’ pensions do not match or exceed inflation, they will have less cash to spend, which means that less money will cycle through the local economy.

The broadest response to such claims is that every dollar paid into the public sector pension system has to come out of the economy in the first place, most of it reducing local buying power in order to fund national and international investments. In that light, General Treasurer Gina Raimondo’s proposed reform — any reform — would count as stimulus. The state’s pension actuaries, Gabriel Roeder Smith & Company, estimate that the retirement system will require state and local governments to contribute $659 million in fiscal year 2013 without reforms, but only $383 million with the proposed reforms. That’s a difference of $276 million that taxpayers could use to pay bills, purchase goods and services, and make investments.

Meanwhile, additional data from RIOpenGov.org shows that the pensions paid out in 2010 were augmented by $176.0 million for total COLAs already applied to base pensions. In other words, while special interests are arguing that freezing COLAs at their current level would harm Rhode Island’s economy, the state could erase COLAs from the pension system entirely and the economic harm still wouldn’t amount to two-thirds of the economic benefit that the current (arguably too restrained) reform would represent for local economic activity.  (All of this leaves aside, of course, the additional benefit of proving that the state is interested in securing its future.)

And as the total pension dollars sent out of state show, that’s not the whole picture. If COLAs are distributed equally among retirees in state and out of state, $149.6 million of the money paid to retirees who live in Rhode Island is attributable to the adjustments. That means that completely eliminating every penny of current COLA payments would have about the same economic impact, in Rhode Island, as paying for the retirements of people who don’t live here.

Whether these amounts are significant in a $47.6 billion state economy is a matter of opinion. So, too, is the legitimacy of various changes and restrictions that the state could consider imposing on pensions. When assessing the impact of reform, however, it is critical to consider the many ways in which Rhode Island’s public-sector pension system interacts with the economy.

As part of the national task force that our Center has assembled, Jagadeesh Gokhale, from the Cato Institute, published the OpEd below that appeared in the Providence Sunday Journal, Oct. 23, 2011.

R.I.’s pension debt worse than admitted

JAGADEESH GOKHALE

WASHINGTON, DC -Rhode Island’s pension crisis reminds one of Greece, now slaving under externally imposed austerity — the fruits of engaging in systemic deceit.

Lavish retirement benefits, including automatic inflation adjustments, awarded to state employees have resulted in future pension obligations of $11.5 billion in today’s (2010) dollars. But the state has assets worth only $6.8 billion on hand to cover these obligations, implying a funding ratio of less than 60 percent.

In addition, the state provides other post-employment benefits (OPEB) to its employees (general employees, teachers, police, judges, legislators, and so on) — whose present valued obligation amounts to $8 billion. This obligation is completely unfunded — that is, benefits are paid out of current revenues each year.

Adding it all up, the official measure of total pension and OPEB liabilities as of 2010 is $12.3 billion and the unfunded component is $5.5 billion.

Taking the numbers at face value, the state must make up this $5.5 billion shortfall in retiree pension and OPEB programs by increasing the share of general fund budget devoted to covering accruing pension obligations and amortization costs.

State general fund revenues amounted to $5.5 billion in 2010, of which 4.2 percent is contributed to meeting current benefit accruals and amortization costs. The state’s pension obligation amortization schedule extends to about 20 years, but OPEB obligations will remain unfunded.

Unfortunately, the reality that is most likely to unfold in the future is much worse. The accounting methods used by the actuaries amount to sugarcoating the situation. The true magnitude of the Rhode Island’s pension and retiree health underfunding problem is larger by billions of dollars.

As economists have repeatedly asserted, because pension benefits are guaranteed, they should be evaluated by discounting future benefit flows using a relatively safe rate of return — on the order of 3 percent per year in inflation-adjusted terms. Pension actuaries, instead, use the much higher rate of return they expect on the pension fund’s assets — which are usually invested in risky private equities and bonds.

This accounting treatment undervalues (ignores) the risk that the relatively fixed and certain benefit obligations would have to be paid out of additional taxpayer funds because the pension fund’s asset portfolio suffers losses from a market downturn precisely when it must be drawn upon (sold) to fund benefit obligations coming due.

Discounting future benefit flows at a risk-adjusted rate of interest, however, is politically unpalatable because it results in a much higher measure of pension liabilities and increases the current funding burden on the state’s budget.

In the case of Rhode Island, the state’s Comprehensive Annual Financial Report for 2010 (the most recent available) specifies an expected return on pension assets of 8.25 percent. The present valued pension and retiree health liability reported earlier are calculated using that discount rate.

However, using a risk-adjusted rate of return in evaluating the pension liability, and incorporating a 2 percent annual growth rate of the retiree population, shows that the total accrued pension and health liability would be 56 percent larger — or $18.7 billion instead of the official total of $12.3 billion. And the unfunded liability component would be $11.9 billion instead of the officially reported $5.5 billion.

There are other concerns, as well, regarding the level of contributions being made by Rhode Island to amortize this liability and the management of the pension fund’s investment portfolio. Ongoing reform efforts are likely to affect current and future state employees, but the understatement of pension liabilities hides the size of taxpayer exposure to future pension funding shortfalls.

A thorough exploration of feasible pension reform alternatives in Rhode Island is urgently needed. Unfortunately, the underlying data on historical earnings, job tenure and other information on state pension plan participants has been kept under wraps by the authorities.

This impedes transparency and the ability of state lawmakers to analyze and draw upon new ideas on how to resolve the state’s pension funding dilemma and improve the programs’ financial condition over time. That has to change soon if there is to be any hope of dealing with this crisis.

Jagadeesh Gokhale is a senior fellow at the Cato Institute in Washington D.C.