My colleague (and fellow high school alum), Josh Rauh testified on the new systemic risk posed by underfunded state and local pensions. Why is this a systemic problem? Because, if cities and states start defaulting and/or massively raising taxes, will you let these elderly retirees go hungry and/or without healthcare? Remember, they are not eligible for Medicare and Social Security – their pension is their safety net. They took jobs and worked for the public sector at given wage and pension promise. Maybe some of them got good deals, maybe some of them got overworked for too little money. But they all taught our children, protected our lives, administered the services which we take for granted, and so on with pay and a promise of a pension and healthcare. But the politicians gave us lower taxes or higher benefits instead of setting aside the money to pay for the pensions and healthcare that they were promising to public employees while they worked. Now the workers are old and the bills are coming due. And some states are woefully underfunded (see here).
We in these states and localities have four options: pay more taxes, drastically cut spending, default on debt, or default on our promises to these elderly. In Illinois, up until the latest tax increase, we have such a big hole that if we cut all spending – 100% of schools, cops, everything – our projected taxes would just about cover our pension and benefit obligations. The recent tax increase is a small and temporary fix to a major problem. (Is it just a coincidence that so many of our governors end up in prison?)
Now the question is, what of these scenario’s is not systemic? Default on debt looks pretty systemic. If states and localities default on debt, these defaults will reduce the assets of other local governments’ pension funds and presumably some private defined benefits plans and whatever foreign institutions hold the debt also, oh, and probably banks. A large increase in state and local taxes sure sounds systemic. As does massive cuts in spending – poor law enforcement, public education, public health etc are national problems. And in the case of defaulting on pensions and healthcare, won’t we through the Federal government step in to stop elderly from dying of minor infections and starving, especially after these people worked their lives for these benefits?
Josh’s testimony is here. Very troubling but worthwhile reading.
Everything Finance 
Quoting …”We in these states and localities have four options: pay more taxes, drastically cut spending, default on debt, or default on our promises to these elderly.”
These options (especially the last) need further discussion.
(1) Most (although arguably not the civil Servant recipients themselves) would agree that pensions and retiree healthcare benefits of the “average” civil servant are significantly greater than their Private sector counterparts. To proceed (and since I’m quite knowledgeable in this subject), I’ll quantify it by saying that the taxpayer-funded share of the “typical” Public Sector retiree is 2 to 4 times greater than their comparably paid Private Sector counterpart, and 4 to 6 times for “safety” workers due to their even richer Plans.
(2) A great many current Civil Servant retirees are not elderly, with most Civil Servants retiring 10+ years earlier than their Private sector counterparts. Many are still working while collecting their pension.
(3) Although Civil Servant Unions like to says that “investments” pay for 50% and sometimes 75% of their retirements, anyone versed in finance knows this is hogwash. The only true SOURCE of contributions is the employees themselves and the employer (meaning taxpayers). Investment earnings is simply a RESULT of these contributions (and would have stayed in the the contributors pocket in the absence of the original contribution). On average the Public Sector employer (meaning the TAXPAYERS) pays for 80-90% of Public Sector retirement Plan costs.
(4) Anyone who hasn’t lived under a rock for decades is well aware of the quid-pro-quo (you-scratch-my-back, and I’ll-scratch-yours) arrangement between Civil Servant Unions and our “elected officials”. It’s easy to promise excessive pensions and benefits when it’s SOMEONE ELSE’S MONEY and you are personally benefiting from the decision.
With (1)-(4) as the backdrop, and Private Sector citizens so unable to save for THEIR OWN retirements (to a large extent due to the taxes needed to fund the excessive pensions and benefits of Civil Servants), how can we OTHER THAN conclude that WAY BEFORE we ….. (a) raise taxes, (b) make further service cuts, or (c) default, …. we (A) FIRST substantially reduce the rate of pension accrual for FUTURE years of service for CURRENT (yes CURRENT) Civil Servants, and (B) “consider” selective pension reductions for those already retired, the most egregious example being 45 year old retired policemen with pensions equal to 90% of their final pay.