When Wisconsin erupted in labor strife last month, Tri-State residents could watch on like audience members at a Jerry Springer show, enjoying the vitriol without fear that they have anything to lose. But the problems underlying theWisconsin fight are also at work in Maryland, Pennsylvania and West Virginia—and in far worse degree in those first two states. And no matter what decisions will ultimately be made in Annapolis, Harrisburg or Charleston, both public employees and taxpayers are already the losers.
The headline problem in Wisconsin is the state’s budget deficit, brought on by lower-than-expected tax revenues following the recession, coupled with over-optimistic government spending plans. Wisconsin must close a projected $137 million deficit by July,[1] and expects a $1.8 billion deficit next fiscal year and another billion-dollar deficit the following year.[2] To put those numbers in perspective, the state’s annual general fund spending is $14 billion.[3]
Wisconsin is not alone in battling red ink; more than 40 states face deficits in fiscal 2012. Maryland’s expected deficit is $1.6 billion—12 percent of its general fund budget. Pennsylvania faces a $4.5 billion deficit—18 percent. Frugal West Virginia has only a $155 million deficit, but that’s still 4 percent of its general fund budget.[4]
But the real problem in Wisconsin—the one underlying the labor fight—is in the long term. Like most states, Wisconsinpays its public workers with a combination of wages, current benefits and promises of retirement income and benefits. There’s nothing wrong with that. Individual workers have diverse preferences for their pay: some want it as wages up-front, others accept lower wages in return for better benefits and greater job security, and still others accept modest pay while working in exchange for better income and benefits when retired. Smart employers offer a mix of compensation that attracts desired workers, but at the lowest total cost. Government and its unions believe that public workers are in the latter two groups:[5] they’ll accept slightly below-market wages today, but they want above-average benefits, job security and retirement benefits.[6]
But government’s retirement promises may prove hard to keep. An employer that offers pensions should make regular contributions to a pension fund in order to pre-finance its future obligations. The money should then be invested sensibly, growing the fund so that it can cover its future expenses. To Wisconsin’s credit, it makes the regular payments. However, the state has been counting on healthy future investment returns of around 8 percent[7]—returns that seem unlikely. More conservative assumptions imply that Wisconsin’s pension fund is underfunded by as much as $48 billion. And the state will have to come up with additional billions to cover retirement benefits like health care, as states usually don’t prefund those obligations.[8]
The long-term outlook is worse for Maryland, Pennsylvania and West Virginia, as those states haven’t been good about prefunding. Maryland’s pension funds are underfunded by between $16 billion (assuming good investment returns) and $50 billion (more conservative). Pennsylvania is underfunded by between $21 and $87 billion. West Virginia is underfunded by between $7 and $13 billion. And again, retirement benefits like health care add billions more in unfunded obligations.
Why would states put themselves in such a spot? Government leaders promise good retirement incomes and benefits to public workers, but then do not fully prefund those retirements, in order to keep current labor costs low but make public workers happy. Union leaders look the other way when prefunding lags so they can boast of big negotiating victories. For both sets of leaders, this is a winning political strategy—they get acclaim while the future costs are someone else’s problem.
But the strategy makes losers of public workers and taxpayers. Public workers have less-secure retirements, even though they’ve accepted lower wages in exchange for pensions and retirement benefits. Taxpayers’ predicament is worse: Failure to fully prefund public workers’ retirements means much of the cost of current labor won’t be felt until well into the future. Hence, taxpayers don’t experience both the cost and benefit of that labor at the same time, and so they give little thought to whether the benefit justifies the cost. Or, more accurately, today’s taxpayers get the benefit, while future taxpayers get the cost. That’s neither efficient nor fair, and is a recipe for big government now and fiscal crisis later. And that’s why both public employees and taxpayers—or, more accurately, current public employees and future taxpayers—are already losers.
And if you think this is lousy policy, consider that Social Security and Medicare work much the same way.
