Pooping the Pension Party

Illinois, my current state of residence, has a problem. They have historically failed to pay into the retirement system the amount of money they were due. They face an $85 billion liability, one that will now continue to grow.

At issue is a provision in the Illinois Constitution that prohibits diminishing pensions. People who have taken government employment rightly expect to get paid what they were promised. For decades, they made financial decisions on the faith that when time came to retire, they would have a stable, dependable, and sufficient income.

They won’t.

I too would be a bit miffed if I had been promised a certain income and then had it taken away, especially if the reason were that my employer failed to hold up its end of the bargain. Sadly, no amount of righteous indignation is going to pay the bills. At some point, the system will collapse completely.

How can people make such bad economic decisions? That is, how can a state retirement system get it so wrong? The most obvious factor is the unethical behavior of the state, which did not contribute its part. As it is with Social Security, the assets of which have been replaced by IOU’s, government played a shell game–only the state cannot print its own money.

No one who does not still believe in Santa Claus is surprised that the state cheated, but there is a more fundamental problem with state retirement systems. They distort economic signals that would otherwise price out retirement costs accurately.

Predicting the future is a dicey business at best, yet we cannot avoid doing it. The vast majority of a human being’s life is premised on what he/she thinks will happen. Will the game return on the full moon? Will the White House change parties next election? Will Oprah get another award?

Many of these decisions hinge upon what others will do. We predict their decisions as part of the mix. Markets, or at least free markets, take all these predictions into account. Retirement instruments are one example.

When large numbers of people wish to invest for the future, someone sees an opportunity to make a profit–a good thing, if you will recall. That person puts together a package of investments and sells units of it. There are dozens of kinds of these instruments, but under a free market, they all have one thing in common. They are priced on commonly shared expectations about future prices. Taken all together, the expectations of future prices allow the current price to be set. Obviously, no prediction of the future is perfect, but the collective wisdom of a free market does one heck of a good job.

Enter unions and the state. Unions work by uniting thousands of people to bargain together. Nothing wrong with that per se, but that is not the end of it. Unions also have an advantage in that employers must bargain with them. In the present case, the people who bargain on behalf of the state do not pay–we taxpayers do. Neither side has any reason whatsoever to make sure that the math behind the pensions works. Normally, tension in a transaction between the payer, who wants to pay as little as possible, and the recipient, who wants to receive as much as possible, works itself out to an accurate price. In this case, the price is how must one should pay now to expect a certain amount upon retirement.

Living under the illusion of a lucrative retirement for a bargain feels good, which is why no one until the last year or two wanted to blow the whistle. Now that even a five-year-old can figure out that it ain’t a gonna happen, the state legislature is doing what legislatures do best–ignoring the problem.

I wish no ill whatsoever to union members or anyone else who bargained for a good retirement. What they were promised should be delivered. Problem is, it can’t be. No power on Earth can overcome the inevitable sway of the market. All those promises made years ago now depend upon current taxpayers paying up. That was not how it was supposed to work. The state lied about how pensions would actually be paid and further, it cheated by not paying in its share. The result is a set of extremely angry people and a pension system that will soon be able to pay no one anything.

At this stage, I frankly doubt that there is a legislative solution. Were the state to hack taxes to a fraction of their present level, eliminate something like 90% of what the state currently does, and spend most of their time undoing stupid regulations on business, we might get out of this with only cuts and bruises. Don’t count on it. The party is over. The only real solution is for individuals to act as if their pensions are gone already. They may have to start a business, live more frugally, invest wisely, or a combination of all three, but they (we) are on our own. Maybe we will have learned enough after that to make sure we don’t set up the same catastrophe for our children and grandchildren. Too soon old, too late wise.

About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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2 Responses to Pooping the Pension Party

  1. Diane Benjamin says:

    You better hope the unions don’t see this! Hope you can pay for a body guard. Gee-somebody in education telling the truth. Novel idea.


  2. Terry Noel says:

    Hee hee…you slay me, Diane. Glad you are on our side.


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