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Notwithstanding the 10th Amendment, the federal government has repeatedly stepped in when the states’ political systems failed to bring about necessary action

Andrew Sidamon-Eristoff

Prediction: Sometime in the foreseeable future, the federal government will step in to address the self-inflicted crisis in state and local government pension and health-benefits funding. The only real question for us in New Jersey is whether it will happen soon enough to save us from ourselves.

How and why? Let’s review where we are:

First, state and local governments in the U.S. face a multi-trillion-dollar shortfall in public sector pension and health benefits funding. This is a genuine and growing financial crisis that clearly threatens our nation’s long-term economic prosperity.

Second, although some Democratic states with powerful public-sector unions like New Jersey and Illinois are comparatively worse off, few if any states can afford to relax and ignore the problem, especially if the analysis considers local government liabilities, rising healthcare costs, and unfunded post-retirement health benefits alongside pension liabilities.

Finally, the existing political environment, in which public employees are by far the most active and powerful constituency in state and local government, means that most blue states and many red states lack the political capacity or will to “solve” their benefits funding crisis on their own.

Unfortunately, New Jersey provides a convenient case study. By some calculations, New Jersey’s unfunded liability for state and local pensions and state health benefits combined tops $178 billion, among the worst in the nation. Further, 2017 is a gubernatorial election year. The Democratic frontrunner (and thus likely next governor) has secured the support of the state’s public-sector unions in part by rejecting a bipartisan commission’s well-regarded reform recommendations. Those reforms include a proposal to use savings from aligning public employees’ health benefits with Obamacare “Gold” level benefits to help fund the state’s annual pension contribution. Instead, the frontrunner would fully fund pensions along with an ambitious spending agenda by increasing taxes on “millionaires” and closing corporate tax “loopholes.” Trouble is, as even the multimillionaire frontrunner might admit in private, New Jersey’s economy and voters do not have an infinite tolerance for higher taxes, even on corporations and the rich. The likely result will be half measures to keep the ship afloat a while longer and continued deferral of comprehensive reform.

Cue federal intervention. Notwithstanding the 10th Amendment, over the course of history the federal government has repeatedly stepped in when the states’ political systems failed to bring about necessary action. An early example is the Compromise of 1790, whereby the federal government assumed the former colonies’ Revolutionary War debts. A more recent example is federal civil rights legislation made necessary by many states’ demonstrated political incapacity (refusal) to extend the rights of citizenship to all their citizens.

Today, New Jersey and many other states have political systems that are failing to address the escalating benefits-funding crisis. As the crisis begins to restrict and ultimately bar some cities’ and states’ access to the capital markets, exposing the national economy to widespread risk, the federal government will be forced to intervene. Although I cannot predict precisely when or how this will happen, I’ll throw out some ideas to stimulate thinking.

What form will federal relief take? There are many possibilities, but it’s safe to say that rescuing pension systems will be the first priority because rating agencies and current government counting rules place a greater emphasis on unfunded pension liabilities, often protected by state constitutions, than on unfunded retirement health benefit obligations. (Look for that to change soon, but one thing at a time!)

One option would be to extend the federal Pension Benefit Guarantee Corp.’s pension-insurance programs for private employers to public employers. However, the PBGC’s insurance only supports a statutorily defined maximum guaranteed benefit, which in practice results in substantial reductions to middle- and-higher income retirees’ benefits. Moreover, the PBGC is already functionally bankrupt and the model of providing insurance to pay pension benefits on behalf of terminated private employer plans may not be readily transferable, or appropriate, for state and local public employers.

In the absence of a new federal insurance scheme, the most likely option is federal assistance that helps state and local government pension systems refinance their unfunded accrued liability (UAL). For instance, the federal government might lend the states the money on favorable terms, or it could provide a debt-service guarantee in support of state and local pension-refinancing bonds. Either approach would be tantamount to nationalizing state and local pension liabilities, and as such would be controversial. Not impossible, but highly unlikely.

A more limited, and perhaps more politically palatable, approach would be to provide a federal interest subsidy for pension-refinancing bonds. There is precedent. The federal Build America Bond program, part of the 2009 American Recovery and Reinvestment Act, subsidized 35 percent of the interest on state and local bonds issued for capital expenditures.