Disinherited. Diana Furchtgott-Roth

debt for pensions and other post-employment benefits. This does not even include the pension or capital-market debt of cities, counties, and other local government entities. A true picture of America’s fiscal position should include all levels of government liabilities.

      To cover the total unfunded pension liabilities of state governments, each person in the United States would have to pay $15,052.³⁶ But there is a vast spread between states. Tennessee is in the best financial shape, with $6,531 per person in liabilities. It is followed by Wisconsin, at $6,720; and Indiana, at $7,304. Alaska is in the worst shape, with $40,639 per person. In the continental United States, the state in the worst shape is Illinois, at $25,740; followed by Ohio, at $25,028; and Connecticut, at $24,080. Both red and blue states face towering unfunded promises because the defined-benefit pension system allows politicians from all parties to grant something for nothing—and to defer the inevitable bill.

      During economic booms, states deliver more-generous pensions to their employees, but during economic downturns, these increases are rarely pared back. This means that states make promises to public-sector unions that they usually cannot afford.

      Absent major concessions, these pensions will have to be paid over time to the 19 million men and women who work for state, county, municipal, or school-district government. If pension-fund income is insufficient to cover these obligations, as is expected, the burden will shift further to state taxpayers. If Washington decides to bail out the states, all American taxpayers, no matter how young, will be liable for these irresponsible promises.

      This dire debt has arisen even though the National Association of State Budget Officers found that 49 states had balanced-budget requirements in 2008. Forty-four states require the governor to submit a balanced budget, 41 require the legislature to pass a balanced budget, 37 require the governor to sign a balanced budget, and 43 prevent the state from carrying over a deficit.³⁷

      How has this happened? Even when there are balanced-budget amendments, states are often free to use different funds that are not required to be in balance. The balanced-budget requirements typically apply only to general fund budgets. This leaves large amounts of revenues and expenditures free from budget constraints.

      Many states can also issue debt to balance their budgets. It is not surprising that, just like the federal government, state governments pass their bills to future generations. Cash-based accounting schemes allow states to issue debt as a way around balanced-budget requirements. Loan proceeds are counted as revenues under cash-based accounting. Even though loans have to be paid back, states can meet their budget requirements by not counting debt due in the future and by shifting expenses from one year to another. Under cash accounting, if a state owes $10 million in annual pension contributions but puts in only $5 million, the budget is still considered “balanced.” All this does is postpone the payment of the debt. This is why cash-based accounting is not a widely accepted method for businesses. The Securities and Exchange Commission only recognizes accrual-based accounting, a far more accurate indicator of an enterprise’s fiscal condition.

      States were lulled into complacency because a growing economy propelled increases in stock prices for many years, enhancing the coverage of many pension plans, public and private. Pension systems faced a surplus of funding, and they boosted benefits without regard for future market possibilities. Before the Fed’s three-part venture into quantitative easing, interest rates were higher, too. Prudent planning cannot assume that interest rates will rise to prior levels or that stocks will resume their prior course—state budget projections need to reflect this reality. States must devise ways to reduce their debt so as not to burden their taxpayers, present and future.

      Even when financial markets perform relatively well, they do not regularly create a return as high as estimates that state pension plans use (usually 8 percent). The past few years have seen large gains in equities, which have helped the balances of pension funds. But when declines and sluggish growth from the previous years are taken into account, funds do not meet rosy projections. There is no tidy approach to resolving these problems. The states are essentially autonomous, free to pass the burdens of their spending to the young.

      In other research, the Pew Center on the States, a nonpartisan research organization based in Washington, estimates that 34 states have funding levels below 80 percent of full coverage.³⁸ In 2010, Wisconsin was the only state with a fully funded public-pension plan.

      In the public sector, gains and losses were smoothed over a longer period, typically five years. The Governmental Accounting Standards Board, a nonprofit organization that influences how governments report their pension finances, is proposing that public-sector plans do away with smoothing and instead use market valuations of their assets.³⁹ This would correct one of the transparency problems that have led to public funds’ incurring greater near-term deficits than private plans. The disparity, and potential effect on future generations, suggests that states and cities need to be disciplined and held accountable.

      Even more problematic are the high discount rates used by public-pension plans. These rates cloud the plans’ true costs. When a higher discount rate is used, plans appear to be better funded.

      Pension plans are supposed to be safe investments. There is no reason to expect a consistent return of 8 percent on investments that are not risky. Using a discount rate that represents actual returns makes plans’ fiscal conditions look worse, but showing an accurate picture of funding levels is something that benefits all stakeholders—public-sector workers, retirees, elected officials, and taxpayers. How can policymakers achieve their goals if they do not have a clear picture of what is going on? In other words, lying with numbers does no favors for anyone.⁴⁰

      Although private plans can reduce employee benefits and increase contributions to bring underfunded plans into financial health, some public-sector plans have been prohibited by the courts from doing this. New employees can be charged a higher contribution rate for lower benefits, but not current employees who were hired under more favorable terms. A municipality in bankruptcy, such as Detroit, can restructure its pension obligations—but not all cities want to, or should, go bankrupt.

      Instead, states could gradually raise the age at which government workers can retire. In some states, employees can quit at 50 and start collecting benefits, at the same time as they get another job—and start accruing a second set of pension benefits. Alternatively, states could allow workers to retire at the same age but postpone the age at which they begin to collect benefits.

      States could convert their defined-benefit pension plans to defined-contribution plans, thereby eliminating the addition to future pension liabilities. As to what we must do to fix the current crisis, either older workers and retirees will have to accept lower payments or tax increases will be necessary. The switch to defined-contribution plans has been the trend in the private sector. Only union-managed multi-employer plans are sticking to their defined-benefit status, and many of these are in poor financial shape.

      States could also reduce the power of the public-sector unions. Wisconsin, which has the lowest per-person pension liability, passed a law in 2011 stating that joining a public-sector union would be optional and that the state would not collect dues for unions. The percentage of workers belonging to unions in Wisconsin declined from 14.2 percent in 2010 to 11.7 percent in 2013, according to Labor Department data released in January 2015.⁴¹ This decline was driven by a steep decline in public-sector union membership.

      With Uncle Sam strapped for funds, it is extremely unlikely that Washington will bail out insolvent state pensions. William McBride of the nonpartisan Tax Foundation has estimated that in order to fund our federal deficits, the federal government would need to raise tax rates on people earning over $250,000 to 90 percent or more.⁴¹ This would not cover our deficits for long, because it does not account for the shrinkage in GDP that would result, which would lower the revenue. This is clearly impossible and impractical, but it shows just how dire America’s financial standing has become.

      Alternatively, Washington could make up the revenue by doubling all personal income tax rates, so the top rate would be 80 percent and the bottom rate would be 20 percent. This would raise $493 billion per year, accounting for reduction in hours worked due to higher rates, or $1.2 trillion per year, with no change