The states with huge funding gaps have “behaved badly,” Munnell concludes. “They have either not made the required contributions or used inaccurate assumptions so that their contribution requirements are not meaningful.” She added, “Fiscal discipline simply appeared not to be part of the state’s culture.”
In pensions, as in life, what goes around comes around. In states that have behaved well in the past — such as Delaware — the burden of pension plans will increase in future years only modestly if at all. In contrast, a state such as Illinois, which has perhaps the worst record of avoiding necessary funding even while expanding benefits, will have to increase its pension contributions sharply if it is to meet its obligations.
To get a sense of what looms, assume that, over the next three decades, the plans will earn an average nominal return of 6 percent on their assets. In that case, Illinois will have to raise contributions from less than 8 percent of total state revenue in 2009 to an average of 14 percent between 2014 and 2044. Delaware, in contrast, would need to raise its contribution by only 2 percent of state revenue. The required adjustments in the states with problems need not, and should not, be made overnight, but they will be a drag on state resources for a long time.
The revelation that problems exist mainly in states that have failed to adhere to a credible long-term funding strategy contains a lesson for policy makers in Washington: It is essential to behave responsibly.
Simply hoping our long-term fiscal problems will magically disappear is not a credible strategy. As part of the negotiations over how to address the fiscal cliff — the federal spending cuts and tax increases scheduled to take effect in January — policy makers should combine more support for the economy in 2013 (in the form of tax cuts and infrastructure spending) with a specific and credible deficit reduction plan that rolls out gradually over the next several decades.
Peter Orszag is vice chairman of corporate and investment banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration.