by Nick Giambruno, International Man:
Politicians are always generous with other people’s money… until it runs out.
Near the peak of the late-’90s tech bubble, California’s legislature passed the largest pension increase in its history.
Today, with as much as $750 billion in unfunded public pension debt, California has one of the worst pension situations in the country. But it’s far from alone.
Illinois has a staggering $250 billion in unfunded pension obligations. State pension plans in Connecticut, Pennsylvania, New Jersey, and many other states are taking on water, too.
Unfunded public pension liabilities in the US have surpassed $5 trillion.
Taxpayers Are Stuck With the Bill
There used to be a simple formula for a secure retirement. American workers would work for a big company for decades. Then, at a certain age, they were eligible for a monthly pension check… for life.
Once common, pensions have virtually disappeared from the private sector. Today, less than 4% of companies offer them. It’s another vector in the devalued standard of living of the average American.
Essentially, only government employees get pensions now.
The government isn’t subject to the same constraints as the private sector. So it has no problem promising benefits it can’t afford to pay.
That’s because government revenue doesn’t come from the voluntary exchange of goods or services. It comes from taxes, which it extracts via coercion.
Politicians only care about the next election. So there’s no way to hold them accountable in the long term.
They automatically do the most expedient thing in the short term, like promising extravagant pension benefits. In the long term, their successors have to deal with the consequences.
Naturally, not one of the politicians who voted for California’s record pension increase is still in office.
It’s bad enough that politicians give themselves and other state employees extravagant retirement benefits and stick the taxpayers with the bill.
But the story gets worse…
Government pension plans use all sorts of accounting wizardry that would land someone in the private sector in prison.
Bernie Madoff Math
The single most important number for a pension plan is its assumed rate of return. This is the rate the plan’s investments are expected to make.
As in other areas of life, the government takes special privileges here. It uses accounting practices that the private sector can’t—not legally, anyway.
Essentially, government pension plans choose whatever rate of return they’d like.
Lawrence McQuillan—a senior fellow at the Independent Institute—says that government pension plans “work on the assumption that they’re going to generate returns 25% higher than Warren Buffett every single year into perpetuity.”
These assumptions are totally disconnected from reality.
Government pension plans overestimate investment returns using unrealistically high rates of return. They routinely pull numbers out of thin air.
The results they come up with are insane.
In effect, this artificially shrinks a pension fund’s liabilities, making it look more solvent than it really is.
In other words, the government is using Bernie Madoff math.
This lets politicians contribute less money than the fund needs to be truly solvent. That, in turn, frees up money to bribe constituents for votes, or do whatever else the politicians want.
On average, government pension plans assume about a 7–8% rate of return (even after years of underperformance).
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