An IPOD Without a Happy Tune
By Chuck Reed
Analysis published this week by J.P. Morgan’s Chairman of Market and Investment Strategy Michael Cembalest introduces an interesting means to aggregate public pension debt burden and calculate the amount of tax increases or service cuts that a state will have to pay for future obligations. Unfortunately, even with the new way of calculating pension liabilities, the forecast is dreary for many U.S. states.
In his analysis, Cembalest calculated what all 50 U.S states currently spend on bonds, pensions and obligations related to underfunded pensions and retiree health benefits (termed OPED) and what they would be spending over 30 years assuming a 6 percent rate of return. Of the 50 states, four—Illinois, New Jersey, Connecticut and Kentucky—stand above the rest in future obligations and represent 20 percent of outstanding municipal general bond obligations.
Using a calculation called “IPOD” (short for I=interest on bonds, P=pension payments, O=OPEB payments and D=defined contribution payments, all divided by state revenues), Cembalest looks at current IPOD ratios and, more importantly, full accrual IPOD ratios required to service all future obligations accrued to date. And the result does not carry a happy tune. To meet the full accrual IPOD ratio, many states will need to significantly increase taxes, cut services or increase public worker contributions.
For example, to meet its future commitments, Illinois will have to increase taxes by 17 percent, or cut spending on services by 16 percent, or increase worker pension contributions by 400 percent. In Connecticut, policymakers will have to increase taxes by 14 percent, or cut spending by 14 percent or raise workers’ contributions by an outstanding 699 percent. In short, the situation is dire for not only the four states used in the example, but many more throughout the country. Further, Cembalest’s research only digs as far as the state level. Examination of municipalities using the same formula would only further reflect the tremendous debt burden.
So, what does this mean? Looking at the varying scenarios, increased taxes for most of these states will likely be politically impossible since the highest IPOD ratio states already have the highest taxes. Increased spending and worker contributions will also likely be off the table. Combalest says that states could rely on elevated investment returns, but that would require almost impossibly high annual returns for 30 years and, after all, that shortsighted optimism is what helped get our country into its current pension debt crisis.
Moving forward, pension reform can no longer be prolonged by state and municipal policy leaders while liabilities accumulate. To maintain benefits for current retirees, ensure a fair retirement for future workers and deliver government services to taxpayers without significantly increasing revenues, the debt crisis needs to be addressed now.