By all measures, state and local government employee pension funds are significantly underfunded. By standard accounting methods, some state pension funds will run out of assets within as little as five years. When this happens, states will have to use general government tax revenue to pay their pension benefits, which in most cases hold the highest priority of payment. Depending on states’ constitutions and their individual policy choices, maintaining full pension benefits without sufficient pension fund assets will require tax increases, cuts in government services, or additional debt issuance. When these austerity measures prove too severe for states and localities to handle – politically or economically – governors and mayors will inevitably come to Washington requesting federal bailouts. And despite the massive federal debt and fiscal imbalances, it will be hard for Washington policymakers to deny sympathetic retired teachers, police, and firefighters after a previous Congress bailed out Wall Street and the U.S. automakers.
When the states with the worst pension systems come knocking at Washington’s door for a bailout, it will ultimately be taxpayers in more prudent states who will pay for the recklessness of the negligent states.
Already, federal grants to the states result in significant income redistribution. For example, the five states with the highest level of per capita federal grants receive nearly three times as much as the five states with the lowest amount. And the five states with the highest per-capita federal tax burden pay more than four times as much in total federal taxes as the five states with the lowest burden.
If the states with the most troubled pension funds come to Washington for a federal bailout, the burden of this bailout will be borne disproportionately by states that already pay the highest share of per capita federal taxes and states with relatively sound pension systems.
As more and more states come to the federal government for bailouts, taxpayers in fiscally sound states will grow increasingly frustrated and hostile toward the fiscally reckless states. This tension could lead to a severe divide between the fiscally responsible and irresponsible states, just as we are seeing occur in the Eurozone today.
The only way to prevent a federal bailout of state pension funds is for states to take action today to curb their underfunded and unsustainable pension systems. Enacting pension reform will not be easy, particularly in the states with the greatest unfunded liabilities, but if a federal bailout remains on the table, states will have no reason to impose fiscal discipline.
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