Skyrocketing Pension Costs Mean Higher Taxes or Fewer Services

Government pension plans promise to pay current and future retirees a benefit based on a defined formula. To make good on its promise, government contributes tax dollars to a pension fund and invests them to generate income. But what happens when contributions and investment returns fall short? Will government raise taxes, cut spending, or reduce the promised defined benefit to retirees when the pension bill comes due?

The Wyoming Retirement System (WRS) manages the money to pay the state of Wyoming's retirees. The state employee pension plan, the largest of the eight plans managed by the WRS, held $6.5 billion to pay benefits as of December 31, 2013—about $2 billion less than what it needs to pay these benefits over the life of the plan.

Pension contributions are no small sum. More tax dollars go into the plan than the tax paid into the general fund by the minerals industry—the severance tax. For calendar year 2013, employee and employer contributions to the plan totaled $244.7 million, while severance tax revenue going into the state's general fund totaled $210 million.

It's getting worse. Pension contributions went up in 2013 and 2014 in recognition of the plan's continued unsustainability. In fact, between 2004 and 2013, contributions to the state employee's retirement fund more than doubled, from $121 million to $244 million.

But here's the rub. State employees contribute only a small portion of their pay to the so-called employee contribution, making the employer (read—taxpayer) pick up approximately 90 percent of the total contribution. This means that taxpayers in fact paid $220 million towards the retirement of someone else.

Although a stealth bailout via higher contributions might make it appear as though the pension plan is well managed, there is yet more bad news. The plan pays out more than it collects in contributions. For example, it took in $244 million in contributions in 2013 and paid out $387 million in benefits. This happens every year and means the fund depends on investment returns to ensure pensioners will receive a pension and taxpayers won't be on the hook for a massive future bailout. However, in a year when the market declines and investment returns fall, such 2008 when the plan lost $1.6 billion, and again in 2011 when the investments lost $63.5 million, the amount of money available to pay promised pensions plummets. Hence the $2 billion shortage in the fund.

But never fear. Government can always raise taxes or lower services to taxpayers to make up the difference. So, if you thought you were paying enough in taxes in return for services, think again.

Which taxes will go up or worse, which new taxes will be imposed on unsuspecting Wyomingites? Can you say—income and marijuana tax?

And which services will likely disappear?

We already have an idea. According to a New York Times article[1], when pension and health care costs in San Jose, CA ate up 20 percent of its general fund, the city closed libraries and community centers. It also cut back staff and reduced salaries. Some cities, such as Stockton and San Bernardino CA, and the granddaddy of them all—so far at least—Detroit, have declared bankruptcy in part to reduce their pension liability. As a result, pensioners are seeing a reduction in their pension checks. Technically, states can't declare bankruptcy, but if taxpayers are forced to fund pensions, there will be less money for roads, schools and crucial state spending priorities such as snowmobile trail grooming.

If contributions double every 10 years, forcing taxpayers to put additional funds into state employees' pension accounts, that means government has less for priorities at the core of the function of government, such as the court system—or to leave in the pockets of taxpayers to fund their own retirement. It is time for substantive reform. To provide security to government retirees, and to ensure that taxpayers are also able to save for their own retirements, the state must move to a pension plan in parity with private sector pension benefits.

[1] http://www.nytimes.com/2013/09/24/us/struggling-san-jose-tests-a-way-to-cut-benefits.html?pagewanted=all&_r=0