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The Next Financial Bubble?

by on February 22, 2010

Before starting school in the fall quarter I was in Chicago and came across and article in the Chicago Sun Times detailing the plight of the pension system in Illinois.  I was unable to find a link to that article, but I do recall that it stated that Illinois was paying close to $800 million dollars per month in pension compensation to former employees.  In a more recent article reprinted in the Sun Times by the Associated Press the issue was reiterated, “The Pew Center on the States said states may be forced to reduce benefits, raise taxes or slash government services to address a $1 trillion funding shortfall in public-sector retirement benefits, and warned of even more debilitating costs if immediate action isn’t taken.” I hope this catches your attention as it surely caught mine.  Mapping out the potential effects detailed in the quote from the AP it does not bode well for economic recovery.

1) Reducing benefits.  This is probably the only way to do get the pension plans under control, but what effect are you having on people who had budgeted in this benefit into their retirement?  What percent of pension receivers would have to make one of the following changes:  a) sell their current home to find more modest accommodations, b) spend less in general thus reducing the total amount of cash moving through the economy, c) potentially be a financial burden on the state due to a reduced income.  I will point out that on the other hand their are many former government employees that are reaping the rewards of their government service with annual pensions greater than $200,000 per year.

2) Raising Taxes.  To maintain the burden of the current system, this solution proposes to place the burden on the current generation of workers (“us”) without the same promise of pension levels that the current generation is enjoying.  Raising property taxes could also continue to destabilize the already sensitive housing market which as we have seen recently can have almost catastrophic effects on the other sectors of the economy.  At the very least, higher taxes will mean more money going out into the economy through consumer spending.  How will this affect businesses that are already barely treading water in the current recession?

3) Slash government services.  We are already seeing this in full effect in Washington, California, and Illinois.  Some services may be considered non essential, but the bottom line is that reducing services means reducing jobs which leads to greater unemployment.  In this scenario both the citizens suffer due to having far fewer services that they have come to expect over the years, and the government workers that are being let go mid-career before they can retire with full pension benefits.

This is certainly a wicked problem of high magnitude, that will most likely have a very serious effect within the next five years.  I dare say that if you can devise a solution to this problem that the government may be willing to listen, as they have been unable to solve this on their own.

Study: States must fill $1 trillion pension gap

Muni Threat: Cities Weigh Chapter 9

-Paul Simons

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4 Comments
  1. I have to say, the prospects are looking almost terrifying. I can’t see what option might bring about a sustainable solution without some serious political ramifications.

    I think that the fact it is a deeply political problem, not just an economic one, is what makes it especially tricky.

  2. Deepti permalink

    Agreed!

    Neither of the option looks in favor of common people.
    In one or the other way, these options leads to several different problems which may not be visible immediately but can leave long-term adverse effects.

  3. Jordan permalink

    Paul, I think this is a legitimate concern and even when I worked for the Commonwealth of Massachusetts we were instructed not to rely on our pensions if we were 40 years of age or under (but we were required to contribute to the fund, natch).

    However, there are two variables for which I believe we have not accurately projected the impact: the first is immigration, and the second is the labor force adjustment we are currently experiencing.

    On the first, the immigrant population tends to be younger than the US population. This might help the tax base. On the second, we are going to require a huge adjustment in the health care industry, and the model will hopefully shift to more preventative care with more LPNs and NPs to meet the health care needs of the aging population.

    Just a couple of points related – I agree that the pension model is very much broken.

  4. Paul and Jordan,

    Something about what y’all are saying is… firing something in my brain. Let me see if I can get a few coherent questions together. I kinda like where this is leading my general thoughts.

    Heck. In fact, I think I’m going to skip commenting all together and go write a post. Let’s see what I can do…

    –Ross

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