Too Many Promises
I don’t know what it is about public officials and Ponzi schemes, but the former finds the latter irresistibly attractive almost everywhere. Maybe it’s the fact that the law lets them get away with it. They get off scott-free when they do the very same thing that landed Bernie Madoff in the hoosegow.
Although national attention tends to focus on Social Security, Medicare and other unfunded federal obligations, many state and local governments are in far worse shape. I believe we are on the cusp of a spate of local bankruptcies. Although states cannot declare bankruptcy, they can default on their debt. In California, this seems almost inevitable.
Did you know that the average state has unfunded retiree benefits equal to more than one-fifth (22%) of the income of its residents? Seven states (Alaska, Ohio, Hawaii, New Jersey, New Mexico, Illinois and Kentucky) have unfunded obligations in excess of one-third of their states’ annual income. In Alaska, it’s about half (48%). Take Ohio, for example. The state needs 41% of all the annual income of its citizens right now — in the bank, earning interest — in order to fund its future obligations. And if it doesn’t do that this year, next year it will need even more.
These are some of the findings of an NCPA study by Courtney Collins and Andrew Rettenmaier. Another finding: The real totals are about twice what these governments are reporting. A third finding: Promised health benefits are the fastest growing component of the unfunded liability.
In fact, seven states (Alaska, Hawaii, Connecticut, Kentucky, New Jersey, Michigan and West Virginia) have unfunded nonpension benefits (mainly health care) in excess of 10% of state income. In Alaska its 20%.
Orange County, California, with $1 billion in unfunded health benefits for retired public employees is an example of the problem. The city of Westminster, Calif., for example, has an unfunded health liability greater than its operating budget. To cover the shortfall it needs almost $700 for every man, woman and child in the city, or almost $2,800 for a family of four. Like most other Orange County cities, however, Westminster is only paying its annual retiree health costs and is contributing nothing to fund future expenses.
Reason Foundation scholar Adam Summers reports that the state of California has $500 billion in unfunded pension, and unfunded health liabilities that have grown fivefold over the past decade (from $1 billion to $5 billion) and will triple (to $15 billion) over the next decade.
An Orange County sheriff-turned-felon gets $2,184 a year in health benefits on top of a $217,457 annual pension. A former assistant sheriff gets $5,466 in health care plus a $231,990 pension.
The state of California is the only state that allows pensions to be based on the last year of work — meaning that overtime for that one year produces extra income for life. Health care benefits for California public employees are also generally lifetime benefits.
Question: Should the criminal statute that applies to Bernie Madoff also apply to public officials who claim these promises are paid for when in fact they are spending the money (just like Madoff) on other things?
Question No. 2: Should the criminal law that applies to people who hawk Madoff-like schemes to gullible investors also apply to newspaper columnists who try to tell us that government Ponzi schemes are fiscally sound?
The bigger question is whether it is possible to adjust our governing processes and structures so that the outcomes described here, and others, are no longer the natural consequence of the regrettable, but expected, political selfishness of legislators. This was the objective of the original 1787 Constitutional convention. We need all of the original safequards, checks and balances, and more. It is time to open the bigger debate.
Two things.
First, Social Security isn’t correctly described as a Ponzi scheme. A true Ponzi scheme is a pyramidal structure that *must* collapse because some people will be at the end of the line and will have no “next player” to whom they can pass the unfunded asset being traded. Social Security would have worked fine (though that does necessarily mean it is socially optimal) if birth rates had not fallen. If one young person is taxed today to pay the retirement of one old person today, the game can go on forever precisely because there is no last person left holding the bag. That’s not a Ponzi scheme, and it isn’t even dishonest. Were it not for the change in the birth rate, the game could have gone on forever with no one being a loser. In fact, there are circumstances in which an intergenerational transfer scheme can improve social welfare because of Peter Diamond’s “dynamic inefficiency,” well-known to macroeconomists.
Second, I agree completely with Earl Grinols except in one thing: we *already have* the constitutional safeguards. They just have been ignored by activist presidents, congresses, and judiciaries. That raises an important question about the nature of government. Is it possible to prevent social predation? The US constitution has the safeguards, some of them quite explicit, but they are simply ignored. What system could guarantee that safeguards would be binding? Sadly, I think there is no such guarantee, which suggests that the inevitable equilibrium is one with substantial social predation.
John,
If government didn’t have sticky hands when it collected money, what you say would be true.
How do we find out which states and localities are going to default or declare bankruptcy? I assume those would be good places to avoid.
The first sentence is somewhat rhetorical. It’s easy to see why politicians love Ponzi schemes. They can deliver services and promise benefits that future generations (and their leaders) have to figure out how to pay for – long after the scheming politicians are dead or retired.
Every government will run a Ponzi scheme if allowed to do so.
I think it’s interesting that the real unfunded liability is twice what these governments admit to.
Your first sentence is absurd in its naivety.
Of course, I realize you are being sarcastic.
I answer in the affirmative to both questions. We should throw politicians in jail for signing bills that don’t require any savings for pensions funds. Moreover, it should be retroactive and apply to people that are no longer serving but that voted for stuff that impacts us now.
Professor Diamond’s model is, IMHO, overly scholarly, if that is not too critical a term. It assumes politicians with both perfect information and perfect incentives.
The real reason politicians establish plans like Dr. Goodman describes is that it hides the cost of government. If the public-sector employers paid retiree pension and health benefits as cash deposits to 403(b)s and Health Savings Accounts in the years that the workers earn them, then the unionized workers would earn significantly less (measured as Net Present Value of all obligations), because voters would easily observe the actual cost.
However, as Dr. Goodman describes, the union bosses assumed a risk-free discount rate when the actual discount rate is significantly risky! Municipalities will go bankrupt and states and the federal government will not bail them out.
Many people understand that the so-called federal stimulus was, in fact, a bailout of government jobs. This will end with a Republican majority in the House of Representatives.
Furthermore, states and the federal government cannot declare bankruptcy, but their public-sector retirees may well be in worse shape than those of munucipalities and agencies that can go bankrupt. Bankruptcy results in an orderly settlement of claims, whereas default by a sovereign state claiming immunity from debts throws the creditors to the mercy of the citizens’ willingness to pay them off – which I anticipate will result in very poor settlements for government-workers’ unions, given the rising tide of public anger.
It’s not surprising that Courtney/Andrew found that health benefits are the fastest growing component of the unfunded liability.
If patients paid their primary care physicians directly, then they would have health care at $3-5/day.
I’m sure that family and friends could come up with $100-150/month for this service.
Then, the funds pay directly for service and their are no liabilities.
The biggest problem with Peter Diamond’s analysis is that future generations of unborn taxpayers have never agreed to participate and all the mothers-to-be have never agreed to have all those children. For that matter, all those future workers never agreed to work 40 hours a week instead of 20.
How can you call anything welfare enhancing if it’s success depends upon people being forced to behave differently (radically so) than they prefer.
There is no point spending a lot of time on dynamic inefficiency because it the evidence mostly suggests that the conditions for dynamic inefficiency are not satisfied in the US, though some economists are not so sure of that.
For those who are interested, dynamic inefficiency arises when the current generation saves too much because it does not take account of the costs to future generations of maintaining a large capital stock. (Yes, it is possible to have too much capital.) The government can induce a lower capital stock through an intergenerational transfer such as Social Security. The justification for doing that is precisely the same as for taxing pollution to reduce it: there is an externality in the market so that the actions of some people adversely affect other people who are not directly involved in the market activity causing the problem. With both dynamic inefficiency and pollution the government uses its police power to enforce a market intervention that induces people to do things they otherwise would not do. Government action usually involves an element of compulsion. That in and of itself does not necessarily mean the action is bad. Does anyone seriously argue for the abolition of traffic laws?
“How can you call anything welfare enhancing if it’s success depends upon people being forced to behave differently (radically so) than they prefer.”
–Paul H.
Hi Paul,
I’d venture a guess that the underlying assumption is the continuity of shared values–namely the willingness of our society to provide social security (literally, ha!) to its elderly and disabled citizens. Perhaps the private market, through some kind of voucher system, could achieve this end more effectively (personally, I’m skeptical), but people thought differently back then, and it was assumed that the basic human value of caring for the Elderly (not just the ones we’re directly related to) should be embodied through the government, and would persist through the ages. Judging by the current public discourse, including on this blog, it appears that assumption was in error–a significant segment of the population has subsituted self-interest for public interest in their policy preferences. What this says about an American value system (if such a thing exists), is for greater minds than mine to ponder.
SB